Beyond LIBOR: transatlantic divergence in loan markets

11 May 2021

A recent FT Alphaville article considers the state of play in the ongoing transition from LIBOR and usefully focuses on the market impacts.  For those contending with varying degrees of regulatory pressure to move their business to alternative rates, the 'on the ground' realities of the transition continue to be challenging. 

We published an article a year to the day prior to the FCA's recent major announcement on LIBOR's cessation (on which we later commented: The coming end of LIBOR). In it, we considered the promotion of 'SONIA compounded in arrears' as the default alternative to LIBOR for sterling derivatives, bonds and bilateral and syndicated loan markets.  We have since witnessed noteworthy shifts in this direction.  The loan market has taken the longest to get onboard (for good reasons of history and complexity), but the Working Group on Sterling Risk-Free Reference Rates' end-Q1 2021 milestone, for the market to cease initiation of new GBP LIBOR-linked loans, appears to have had the desired effect. Whilst other (acceptable) alternatives are available, the breadth and depth of use of 'SONIA compounded in arrears' grows daily. 

We also addressed the Working Group's and regulators' unease that, should the use of a forward-looking term reference rate derived from SONIA become widespread, it might reintroduce structural vulnerabilities similar to those associated with LIBOR.  Highlighting the global nature of the LIBOR transition, the FT Alphaville piece raises the same issue in relation to the US loan market - noting that the use of a forward-looking term reference rate derived from SOFR (the chosen Risk-free Rate (RFR) for USD) may become significantly more widespread than the fairly narrow uses recommended for an equivalent SONIA term rate for GBP. 

There is still some way to go before a full suite of market standards for the use of RFRs is established (1) for each LIBOR currency (GBP, USD, EUR, CHF and JPY), (2) for all relevant products and (3) in both domestic and international markets.  Indeed, chosen RFRs need not provide the sole 'winner' in every case: to cater for demand across the multifarious US loan market, lenders are expressing serious interest in credit sensitive as well as forward-looking rates for USD, such that SOFR is not the only show in town.  

This particularly uncertain landscape in the US can be pointedly contrasted with the tentative but increasing use of 'SOFR compounded in arrears' for European loan facilities that might be drawn in USD.  All of this adds to already notable transatlantic divergence - most obviously displayed by the currency-specific timelines to LIBOR cessation that were announced in March (see The coming end of LIBOR).  This is causing some difficulties for lenders and borrowers active in both the US and European loan markets and used to more consistency when executing transactions.

So the situation in the US is different. Those involved in the transition, official and otherwise, are more open to using a forward-looking, or term, rate in a wider number of transactions.