Last piece in the SONIA conventions puzzle?

02 September 2020

Phil LloydManaging Director, Head of Customer Sales Delivery

View bio

Other insights

View more insights

2 minute read

The BoE¹ has just released the long awaited recommendation on conventions for the Sterling loan market. This is a significant milestone and has been the primary focus of the Loan Enablers Task Force. On the BoE website there are links to worked examples, Supporting slides and the June Survey Results

In summary:

SONIA² remains the Working Group’s recommended alternative to Sterling LIBOR³, implemented via a compounded in arrears methodology, and loan markets should now move consistently towards this.
Use of a Five Banking Days Lookback without Observation Shift (referred to as the lag approach) is recommended as the standard approach by the Working Group. This aligns with the approach recommended by the Alternative Reference Rate Committee for US dollar loan markets and in the Working Group’s view is most likely to be made rapidly available. Whilst this approach is the recommendation, where lenders are also able to offer lookback with an observation shift this remains a viable and robust alternative (see the worked examples for the comparison between these two approaches).
Where an interest rate floor is used, the Working Group recognises that it may be necessary to apply the floor to each daily interest rate before compounding.
The Working Group recommends that accrued interest should be paid at the time of principal prepayment.

So, lag is the recommendation but the door remains open for shift if parties want to use it. It feels like we've been talking about conventions forever... see 'conventional wisdom' from last year.

Of the various compounding methods, the Bank has not explicitly recommended a specific approach but has stated the market favours compounding the rate rather than compounding the balance. However, there are two compounding the rate options – Cumulative Compounded Rate and Non-Cumulative Compounded Rate. Whilst both return the same result, the latter deals with interim events (e.g. a prepayment) more cleanly. The supporting slides do suggest Non-Cumulative is recommended (page 7).

Where this leaves the bond market isn't that clear noting a desire by some to use the BoE Index which naturally takes you back to shift.

Fortunately with RealisedRate.com we cater for both.

1	BoE	Bank of England
2	SONIA	Sterling Overnight Index Average rate
3	LIBOR	London Interbank Offered Rate

LIBOR

SONIA

This article has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes. It is indicative only and is not binding. Other than as indicated, this article has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of the information contained in this article, nor does NatWest Markets accept any obligation to any recipient to update or correct any information contained herein. Views expressed herein are not intended to be and should not be viewed as advice or as a personal recommendation. The views expressed herein may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this article. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this article and any issues that are of concern to you.

This article does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that are capable of acceptance to form a contract. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not be lawfully disclaimed.

NatWest Markets Plc. Incorporated and registered in Scotland No. 90312 with limited liability. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. NatWest Markets N.V. is incorporated with limited liability in the Netherlands, authorised and regulated by De Nederlandsche Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, the Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, the Netherlands. Branch Reg No. in England BR001029. NatWest Markets Plc is, in certain jurisdictions, an authorised agent of NatWest Markets N.V. and NatWest Markets N.V. is, in certain jurisdictions, an authorised agent of NatWest Markets Plc. NatWest Markets Securities Japan Limited [Kanto Financial Bureau (Kin-sho) No. 202] is authorised and regulated by the Japan Financial Services Agency. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer (http://www.finra.org), a SIPC member (www.sipc.org) and a wholly owned indirect subsidiary of NatWest Markets Plc.

Related insights

Market infrastructure & regulationLIBOR on the ropes but when is the knockout blow?

With all the talk on fallbacks, pre-cessation triggers and term rates you might think we were approaching the end game for London Interbank Offered Rate (LIBOR). But is the industry clear how LIBOR will be dealt its knockout blow, or how it will stagger on?

BOND SUPPLYBondcast podcast: will better growth & higher inflation bring bond bears out of hibernation?

In this episode of Bondcast, Imogen Bachra and the NatWest Markets team of rates strategists – Theo Chapsalis for the UK, Giles Gale for Europe, and Blake Gwinn for the US – discuss the latest vaccination hiccups, and how better growth, higher inflation & more bond supply are being digested by markets.

Market infrastructure & regulationLoan market IBOR credit adjustment - look forward before you look back

On 7 August 2019, the Loan Markets Association (LMA) published a guidance note highlighting considerations in respect of the application of credit adjustment spreads in the context of the move from LIBOR to near risk-free rates.