As pressure mounts on LIBOR origination, cash markets lay foundations for compounded risk-free loans
The pace around the issue of IBOR cessation has been accelerating recently and banks are coming under increasing pressure to stop generating new LIBOR exposures.
Recent developments have brought encouraging signs the loan markets are at last switching on to the need to start writing non-LIBOR loans. While we are yet to see the first syndicated facilities written on a SONIA or SOFR basis, the Loan Market Association (LMA) has published “exposure drafts” of template loan facility agreements that incorporate compounded average risk free rate (RFR) conventions. This follows hot on the heels of the Sterling Risk Free Rate Working Group (RFRWG) paper on conventions for referencing SONIA in new contracts and the issue of at least two bilateral SONIA loans, based on RFR conventions used in the floating-rate note (FRN) market. The LMA drafts are a tangible sign of a shift in momentum first detected earlier in the summer and a recognition that the initial hand wringing around the need for forward-looking term rates has not so far succeeded in bringing such rates to fruition.
Driven as much by the adoption of RFRs in other markets and products as well as the pressing need to start rebuilding treasury management and loan operations systems to work with compounded averaged overnight rates, stakeholders are now turning their attention to narrowing down the various ways in which RFR conventions could be deployed in the cash markets. In particular, options for setting rate formulae and the constituent elements of the rate, frameworks for RFR-based fall-backs, adjustment spread methodologies and critically, the mechanisms needed to align the typical interest period of a loan with interest calculated by reference to daily overnight rates.
Alongside efforts to ready the market for originating RFR loans, there are also plans to streamline the inevitable repapering exercise for legacy deals, with standardised amendment templates in the pipeline. That said, the appetite for forward risk-free term rates has not been sated and the Association of Corporate Treasurers and others continue to make the case for progress on providing a robust term rate alternative. Whether such rates will emerge in time and with sufficient liquidity and regulatory-endorsement before the 2021 deadline remains to be seen.
The International Swaps and Derivatives Association soldiers on with further consultations and draft contract terms and protocols in circulation. In the bond markets almost all GBP denominated FRNs are now based upon SONIA and we have seen an increasing number of issuers switching away from LIBOR using consent solicitation mechanics.
Asset backed securities remain a challenge due to their complexity.
By: Richard Gibbard, Of Counsel Banking & Finance, Financial Markets and Products, Fieldfisher