LIBOR SONIA Transition doesnt Need to be Painful

Libor Sonia Transition - Press Release Header Image

Although firms have become wary of risks and significant costs as they begin to prepare for the transition from the London Interbank Offered Rate (LIBOR) to the Sterling Overnight Interbank Average Rate (SONIA) as the benchmark interest rate, the process of moving to the new rate doesn’t have to be as strenuous as many believe. That’s according to John Byrne, owner of Salmon Software.

Salmon Treasurer, the treasury management system built by Salmon has been recalibrated with new algorithms that will allow firms to make a quiet and easy transition.

“Following our update to the software, our clients will be able to migrate from one reference rate to the other but it’s our job to make that as smooth as possible,” says Byrne. “Our system changes make the process pretty straightforward for the clients. We have one or two that have already successfully completed it.”

LIBOR has been used for several decades as the reference interest rate, and is currently in use on tens of millions of contracts worth more than $240trn globally – from vanilla to complex derivatives to residential mortgages, according to research by Oliver Wyman. But due to the 2008 LIBOR scandals, the Financial Stability Board (FSB) encouraged national and regional regulators to adopt risk free rather than interbank interest rates, which reflect bank credit risk. In the UK, following recommendations by the Bank of England (BoE), Sonia was put forward as the LIBOR alternative.

Although SONIA has been available from 1997, in April last year the BoE – which administers the interest rate – expanded the rate to include overnight unsecured transactions, and announced a volume-weighted trimmed mean method would be used for calculating the rate. SONIA will then appear on the business day after the day the rate related to, and will be published at 9 am. As it’s an average rate it shouldn’t be easily manipulated.

Given how deeply entrenched LIBOR has become both in organisations’ daily and longer-term risk and treasury planning, the recalibration has caused something of a stir among market participants. However, for those with TMS in their backend, the transition should be straightforward.

Byrne points out that the hard work has been carried out at Salmon, removing the complicated work clients would otherwise have to do around recalculating accruals – which against SONIA will have to be calculated against a multiplicity of rates – and complex recalibrations of trading exposures.

“Our clients are likely to have a series of loans and swaps that are currently tied to LIBOR, plus or minus a margin, and they’re going to have to swap those out and link them to SONIA at some point in the future. We have to facilitate that in the system,” says Byrne.

Many of the contracts in place currently run past the 2021 deadline, giving cause for concern that there will be a mixed bag of rates being used. However, Byrne is relaxed.

“Anyone with long term debt or interest rate swaps on their books are going to be stretching them way beyond 2021 – maybe ten to fifteen years beyond it,” he says. “So, I don’t think it’ll be problematic in respect of the time, or when it has to be done, it’s the fact that it has to be done before that date and the fact that firms will have to ‘repoint’ their debt against SONIA within that timeframe. Once it’s done against one period it’s a fairly straightforward operation against subsequent periods.”

As 2021 approaches, a number of organisations have voiced concerns about their readiness – and banks and corporates alike have approached the huge amount of work involved in the transition with varying degrees of haste. For Byrne, however, the work has been completed in the Salmon Treasurer application and firms can now make the transition easily.

“We have the capability to record all the rates that make up the SONIA average interest rate and we have a procedure in the system, and then it’s just a question of shifting off the reference from one table to another,” he says.

“The system will know what to do thereafter. Effectively it’s just a different way of calculating interest and a different way of calculating accruals. It’s just a new set of algorithms. Our clients will be able to make that transition within the system very smoothly.

With a number of corporates still relying on Excel, Byrne points out that SONIA’s complexities mean errors within their Excel models are more likely and great consideration needs to be given to ensure that these Excel models are accurate.

“Without a TMS, it will be really time consuming and will require a lot of checking and verification. It’s not a one size fits all, every loan is different. You could have a multiplicity of rates, and margins and so on. It’s tricky to do it manually.”

Treasury Managers Avoiding Blockchain Like the Plague

Treasury Managers Avoiding Blockchain Like a Plague - Press Release Header Image

It will take four to five years for the treasury management sector to embrace blockchain technology in assisting with calculations of reference rates, according to John Byrne, owner of Salmon Software.

“If you ask any corporate treasurer would they use blockchain as an alternative, you would fit their response on the back of a stamp – they’ll avoid it like the plague. It has no resonance at the moment in the treasury sector where they are taking out big loans, they are going to go with something that they are at least going to be able to wrap their minds around,” says Byrne.

“If they can get their heads around the LIBOR, they can get their head around the SONIA, throwing in the complexity of blockchain – I don’t see that being a substitute for at least four or five years,” he says.

Firms are currently preparing for the transition away from the LIBOR reference interest rate that has been used for several decades, and which is currently used in tens of millions of contracts globally, to the recommended alternatives.

For Paul Dobbs, managing consultant at Catalyst, problems around the increasing number of trades that continue to reference LIBOR is of concern.

“You would think with new trades being created to date that people would start to reduce the trades that they do referencing LIBOR and start to reference the new risk-free rates. The reality is that people still trade in LIBOR more now, which means there are going to be outstanding trades which will mature before 2021, which is great but there will be a whole load of trades that are past that which will need to be changed over as a result,” says Dobbs.

The FCA said in February that there were currently £60bn in bond issuance that reference LIBOR, that will mature post-2021.

Regarding the current standard of technology software that is looking to assist with the transition from LIBOR, Byrne says that the treasury management sector has yet to embrace it.

“In our sector it appears that they haven’t embraced it yet, or they haven’t facilitated it. We’ve come a long way on it because we don’t want to find ourselves in 2021 struggling to put something into place that requires a lot of attention and testing of the calculations,” says Byrne.

“We’ve been through a lot of that pain, and we have a number of clients who have SONIA loans in place or are about to put them in place, or about to migrate from LIBOR to SONIA. They have been asking us for the last year, or year and half, ‘when can we have it,’” he says.

Such is the concern about navigating the transition away from LIBOR that since mid-February of this year, the Alternative Rates Committee (ARRC) has held weekly conference calls where market participants can ask questions on key transition issues.

In a report based on a survey of 150 banks, end users, infrastructures and law firms published on June 25, 2018 by several industry bodies including the Association for Financial Markets in Europe (AFME), noted that there was “a gap between high levels of awareness of benchmark reform and concrete steps being taken to transition from the Ibors to alternative RFRs.”

Artificial intelligence may be needed by banks to create the central register needed across the various departments in order to prepare for the transition, according to Davide Barzilai partner at Norton Rose Fulbright.

“Because of the volume of documentation, and because you have to be certain as to what you’ve got, and the way that banks have developed their systems particularly the very large ones, all the different departments they have not have a central register for all of this information. So, they have to start building that register, and building the systems and processes for that. That’s where artificial intelligence can help speed up processes and take up some of the slack of doing the due diligence for all of this. The technology available seems to be ready and available for application. For Byrne, technology solutions which aim to assist with the LIBOR transition must keep in mind the regulation difference between SONIA being significantly more complex than LIBOR.

“We are pretty agile in terms of our development cycles, legacy systems aren’t. I know how difficult the job is, and I suspect that they are not ready, and I suspect that the push is coming from them to say, ‘look there is a lot of work involved here, can we continue to use LIBOR for another little bit until we get ready,’” says Byrne.

In the loan market additional problems may be arising concerning whether banks and law firms are adopting the loan market association’s (LMA) documentation to bring about a standardized move away from LIBOR, according to Davide Barzilai partner at Norton Rose Fulbright.

“Looking to the practical and legal sort of things you’ve got millions of financial contracts out there, they might be bi-lateral loans just between two parties, or they might be much broader in a syndicated loan concept where you would have multiple lenders, and multiple borrowers and multiple parties, everyone has to come together and agree what they are going to do,” says Barzilai.

“While we have loan market association documentation, so there is some level of standardization it is nowhere near the level of Isda and the derivatives market because bi-lateral loans and banks will have their own forms of loans, loan agreements plus even in the loan market whilst it can be adapted, there can be regional variations and so there is no real all-encompassing standard.

“The latest LMA drafting for this situation where there is a replacement rate, is to makes things a little easier to put forward the amendments, and that is so you wouldn’t need to get full consensus with all the lenders. With some complex lending that might be more difficult, so that is the wording that has been provided in the last six months by the LMA, but the question remains are banks and law firms using that wording regularly, and it is not clear whether it is being fully adopted yet.”

However, the primary concern remains whether differences between the LIBOR rate and the new alternatives will result in value differential, and ultimately someone losing out, according to Barzilai.

“For existing loans, and there are millions of these existing financial contracts out there where institutions relied on LIBOR plus a margin and made their value regiments based on LIBOR reflecting their cost of funds, versus the new rate which may be lower than that figure and then there is that value loss in the differential.”

Information for SONIA Transition Thin on the Ground

SONIA Transition - Press Release Header Image

Though there is no doubt that the London Interbank Offered Rate (LIBOR) is expected to cease by the end of 2021, many in the industry are still trying to get their heads around some of the calculations for the alternative – the Sterling Overnight Index Average (SONIA).

Since 2017, the UK’s Financial Conduct Authority has spoken about the cessation of LIBOR, and the voluntary agreement by panel banks to maintain the reference rate until the end of 2021.

While there is a possibility that LIBOR will not completely disappear within this timeframe, regulators will have to negotiate whether or not the reduction of panel banks’ contribution to the reference rate will be sufficient to continue publishing the rate after the cessation date.

However, Andrew Bailey, the incoming Governor of the Bank of England, in a speech in July 2019 said, “I can offer no certainty to those who have not taken steps to move off LIBOR by end-2021. Many market participants strive for certainty in their contractual arrangements. In order to achieve it, you do need to transition.” This would strongly suggest that there will be no more LIBOR rates published after 2021. So, the message is clear – be prepared.

In a recent letter, the FCA said that market participants should not expect the period for publishing a “non-representative LIBOR based on reduced panel bank submissions would last for more than a short period (i.e. a couple of months, not years).”

And the pressure to prepare is only increasing.

On January 16, the UK’s Financial Conduct Authority (FCA) and Bank of England (BoE) outlined their expectation that market participants cease writing loans referencing LIBOR by October 2020, in a move to further encourage the transition to SONIA. There are a limited number of cases where contracts that continue to reference LIBOR remains appropriate, and this only expected to decrease as we move closer to the end of 2021.

But there are clear signs that the industry has been making concrete moves in transitioning to SONIA.

According to the FCA, in the past six months, over the counter (OTC) swaps referencing SONIAhave increased to £4.5trn a month on average.

Despite these positive signals, many fundamental questions remain unclear about a post-LIBOR market.

For instance, the International Swaps and Derivatives Association on February 5 announced it will once again ask the market for feedback on whether swaps will need to fall back to the recommended risk free rates before the cessation of LIBOR at the end of 2021.

And pressure is mounting on technology vendors to provide all encompassing solutions to be ready for every scenario.


Tech Dependency

It is difficult to fully gauge the level of preparations of the market regarding necessary system updates required to
implement SONIA.

For example, in the loan market, Finastra a tech vendor in the space made changes to its LoanIQ software to implement SONIA-linked functionalities. Approximately 15 out of 60 major financial clients serviced by Finastra – which are expected to update systems for the transition away from LIBOR – have actually completed the switch, Reuters reported on January 13.

The FCA recently approached the asset management industry seeking insight into preparations. In a letter sent to the chief executives of asset management firms on January 20, the FCA said it was collecting data from some firms’ exposure to LIBOR risks.

“We expect to provide further communications on our specific expectations for LIBOR transition in due course,” the letter continued.

This also comes at a time when, in early February, the Alternative Reference Rate Committee – a group of market participants co-ordinated by the US Federal Reserve – sought comment from tech vendors regarding their preparations to transition away from USD LIBOR to the recommended alternative – the Secured Overnight Financing Rate (SOFR). And the BoE, on January 24, held a SONIA update meeting for UK vendors. While many expected the meeting to provide an in-depth insight into the calculations for various different instruments, the conversation focused on reiterating previous warnings that firms must be ready before the end of 2021.

Regardless of the unanswered questions for a post-LIBOR market, and the current rate of updating systems, the regulators could not be clearer – LIBOR is going to end. And there is a competitive advantage for those that get ahead in their preparations.

In October 2019, we announced the upgrade of Salmon Treasurer to cater for the transition to SONIA for Salmon clients. This includes rates setting, interest calculations, accruals calculations and all related accounting journals.

For non-Salmon clients, in September 2020, we are introducing a new SaaS cloud based Salmon Treasurer – SONIA system and service. This service will be available to non-Salmon clients who are looking for a system to help them migrate their portfolio of loans and swaps from LIBOR to SONIA. It will include the following functionality:

  • Recording and maintaining Sonia reference rates
  • Uploading of their portfolio of loans and swaps
  • Rates resetting
  • Calculation of compounded interest following rates resets incorporating the lag
  • Calculation of accruals
  • Accounting journal postings
  • Sophisticated dashboard reporting on their portfolios.
  • Downloading of data from our system to Excel

A similar service will be available for the US equivalent to SONIA – the Secured Overnight Financing Rate (SOFR).

To find out more about this service, contact us at