GBP / SONIA market practice bulletin

In addition to the recent joint communication by ITFA and BAFT, the ITFA Market Practice Committee would like to draw attention to some practical considerations for those of you providing trade financing in GBP.
 
The Financial Conduct Authority (FCA) announced on 5^th March 2021 that all LIBOR settings will cease or no longer be representative with effect from different dates. For GBP this date is 31^st December 2021 for all tenors save that 1, 3 and 6 month tenors may continue to be published using a synthetic methodology. For UK-regulated banks (this includes UK subsidiaries of foreign banks) the implementation of new loans or contracts from 1^st April 2021 with maturities beyond end 2021 must reference SONIA instead of GBP LIBOR, as per the updated recommendations of the Working Group on Sterling Risk Free Reference Rates (RFRWG) published in February 2021.
 
Members will, however, be aware that the RFRWG published a paper in January 2020 accepting that certain products and markets would need to use a forward-looking term rate. A term rate is appropriate where discounting is to take place, as happens in forfaiting and receivables and invoice purchasing.  Term rates may also be appropriate where borrowers need advance notice of their interest costs, e.g. to apply for an allocation of local central bank hard currency reserves.
 
The FCA announcement did not mention any exceptions to the new rules such as those discussed in the January 2020 RFRWG paper mentioned above.
 
Whilst it would have been helpful to market participants for the FCA to have publicly acknowledged the use of term rates in place of compounded rates, the February 2021 RFRWG publication does make clear references to term rates and the work being done in relation to them by the Financial Markets Standards Board. It is therefore implicit, in our view, that the use of term rates is permitted where appropriate.
 
We therefore suggest to our members that the following should be considered:

• There are three Term SONIA publishers (ICE Benchmark Administration, FTSE Russell, Refinitiv); have you chosen one yet?
• The Term SONIA Reference Rate (TSRR) forward-looking rates cover fewer periods than GBP LIBOR did; can your automated calculation systems cope with this (e.g. for interpolation)?
• Are your systems ready to connect to a new feed, or will you manually input the rates?
• Have you properly defined any fallbacks? This could be to other term rates, central bank rates or, as a final fallback, cost of funds.
• If you use one publisher and your counterparty uses a different one, there could be a small variance; are you able to compromise if required?
• Did you want to use cost of funds as your primary term rate, i.e. not as a fallback? This is unlikely to meet with regulatory approval and you would need to explain your position carefully.
• Do you want to add a credit adjustment spread (CAS) to the term rate you use? This should be considered carefully especially where the term rate is above LIBOR.

Please note that this alert only refers to the use of GBP but that similar issues are likely to arise for US Dollars in due course. We will address this in future alerts.

This communication has been produced for the convenience of members of ITFA. It does not constitute legal advice or a recommendation. ITFA assumes no liability for the consequences of any act or omission resulting from the use of, or reliance on, this communication.