Bank of England unveils initiatives to support risk free rate transition away from LIBOR

Maria Nikolova

From October 2020, the Bank will begin increasing haircuts on LIBOR-linked collateral it lends against.

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The Bank of England today announces two new initiatives aimed at further supporting risk free rate transition.

From October 2020 the Bank will commence increasing haircuts on LIBOR-linked collateral it lends against. From the third quarter of 2020, the Bank will progressively increase the haircuts on LIBOR-linked pre-positioned collateral. Haircuts are scheduled to reach 100% (i.e. implying effective ineligibility) at the end of 2021.

The haircut add-on will be 10 percentage points from October 1, 2020, 40 percentage points from June 1, 2021 and 100 percentage points from December 31, 2021.

In respect of Loan Portfolios containing both LIBOR Linked Loans and other loans, SMF participants may choose to either remove the LIBOR Linked Loans from the Loan Portfolios, or alternatively split these Loan Portfolios subject to them meeting the Bank’s standard collateral eligibility requirements.

Further, the Bank is seeking views from sterling market participants on its intention to publish a daily SONIA Compounded Index.

SONIA is used as a reference rate to determine the interest payable on a range of floating rate instruments. Products that currently use SONIA as a reference rate typically pay interest on a periodic basis (e.g. every 6 or 12 months). The interest due is calculated as a ‘compound average’ of the individual overnight SONIA rates across the period. The resulting interest rate is equivalent to a rolling overnight loan over the same period of time, but without the operational overhead of daily cash flows. This calculation is long established as the basis for the OIS market, but requires a large number of data points and may not be familiar to some non-financial end users, including many corporates.

In order to support and accelerate the widespread adoption of SONIA as a reference rate for products such as loans, the Bank plans to provide a simple means for users to work out the compound interest due on products without performing calculations using each day’s underlying SONIA rate.

The Bank intends to publish a SONIA Compounded Index, which is a number representing the returns from a rolling investment earning interest each day at the SONIA rate. The change in this index between any two dates could be used to calculate the interest rate payable on a SONIA product over that period. This is consistent with the approach taken by the Federal Reserve Bank of New York and the forthcoming publication of its SOFR Index.

Subject to feedback, publication of the SONIA Compounded Index is anticipated to commence by end-July 2020.

In addition to the SONIA Compounded Index, the Bank is considering whether – and, if so, how – to publish daily a simple set of SONIA Period Averages. These could directly provide the interest rate payable over specific periods of time (i.e. the compounded rate over the last X days or months).

Responses to the consultation about the SONIA Compounded Index are invited by April 9, 2020.

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