Increased SONIA activity over recent weeks suggests corporates might just be on track to transition their loan exposures as the end of LIBOR hoves into view.
A member survey conducted by the Loan Market Association in November 2020 on the perceived readiness of the syndicated loan market for LIBOR discontinuation found that the percentage of respondents who believed the market would not be ready in time had almost halved from the same period in 2019.
Five months on from that survey and while activity on new SONIA loans has seen an uptick in volumes since the start of April, the picture is slightly different when it comes to legacy exposure.
“We have seen some progress by companies in the last few months to make inventories of affected contracts to understand what fall-back provisions are in place,” says Svenja Schumacher, Assistant Director in Commercial Treasury Advisory at Deloitte. “In terms of the active transition of bank loans though, progress has been mainly confined to larger PLCs.”
Whilst corporates would be advised to ramp up their efforts now, there is still some time to go. According to Stewart MacKinlay, Associate Partner in EY’s UK capital and debt advisory practice, many corporates had to focus on the immediate challenges of COVID-19 during 2020, meaning that engagement with lenders on LIBOR transition was postponed.
“When we look at new loan exposure it was mainly the larger PLCs which took the plunge first,” says Schumacher. “We haven’t seen a lot of active transition of intercompany loan exposure yet but I think it is to be expected that it has lagged external loans and once the latter picks up, the former will follow.”
Any discussion of the availability of non-LIBOR alternatives needs to take account of currency, with the market for sterling alternatives more advanced than its dollar equivalent – although SOFR loans are available.
“For less sophisticated borrowers, base rate works well,” says MacKinlay. “But it is offered by fewer banks and does have higher execution costs for any associated hedging instruments.”
It has been suggested in some quarters that smaller companies could face higher bank borrowing costs under the new risk-free rates and may find it harder to negotiate individual pricing with their bank.
However, MacKinlay says this hasn’t been the experience to date in the mid-to-large corporate market. “Banks have shown the required clarity in separating out any SONIA related costs – such as the credit adjustment spread – from the borrowing margin,” he says.
Schumacher observes that regulators have been clear around the topic of conduct risk and that there will be a lot of scrutiny that IBOR discontinuation should not be used to move customers to replacement rates that are expected to be higher than what LIBOR would have been.
“LIBOR is being discontinued in the first place because it was being manipulated and the transition to an index which is underpinned by actual transactions should make the market fairer,” she says. “We can see that SONIA followed the development of the Bank of England base rate after the rate was cut, whereas LIBOR first followed but then went the other way, peaking at a spread of more than 60 basis points between three months LIBOR and SONIA. So the rate cuts that were intended to support the economy were not passed on to anyone with a LIBOR contract.”
Schumacher advises corporates to get familiar with the various commercial implications of the transition – such as the calculation of credit adjustments – and actively participate in education around the topic. “That way if a corporate felt it was being offered worse terms than before it would have the knowledge and understanding to challenge its bank and dissect the pricing,” she concludes.