Since 1986, The London Interbank Offered Rate, or LIBOR as it’s more commonly referred to, has historically been the cash benchmark rate for a broad range of financial instruments, including some cash, fixed income and alternatives funds. It provides an indication of the average rate at which a LIBOR panel bank can obtain unsecured funding in the London interbank market for a given period, in a given currency. LIBOR is often referenced in derivative, bond and loan documentation, as well as in a range of consumer lending instruments such as mortgages. Common use of LIBOR as a reference point for new business will be discontinued after 31 December 2021. The London Interbank Bid Rate (LIBID), LIBOR’s opposite as it reflects the rate at which funding is sold (bid rate) vs. LIBOR’s reflection of the purchase price (ask rate), will also be discontinued.

SONIA

In the UK, the Sterling Overnight Interbank Average (SONIA), published since 1997,will replace GBP LIBOR beginning 1 January 2022. SONIA is the weighted average rate of all actual transactions above £25 million in London by money market institutions between midnight and 3:30 pm. For term dates the SONIA rate is the cumulative overnight rates for that period, differing from LIBOR set for future time periods.

A closer look at the transition

The UK Financial Conduct Authority (FCA) and ICE Benchmark Administration (IBA) have announced that all calculations across GBP LIBOR, JPY LIBOR, CHF LIBOR and Euro-LIBOR will be discontinued after 31 December 2021, as well as 1-week and 2-month USD LIBOR calculations. Five additional USD LIBOR calculations will continue to be published until June 2023. These should not be used for new contracts subsequent to 31 December 2021.

Given the broad historical usage of LIBOR a “Fallback Rate” to GBP LIBOR will be published for the duration of 2022, after which it is currently expected to cease. This will be a spread to SONIA. The spread adjustment calculation methodology has been agreed upon and will be calculated and published daily for each tenor using a five-year historical median calculation. These fallback rates will be used for derivative transactions traded under the International Swaps and Derivatives Association (ISDA) as well as other financial instruments broadly.

Comparing GBP LIBOR and SONIA

Determining SONIA from observed transactions promotes its transparent setting. The potentially subjective contributions of panel banks to LIBOR can lead to greater opacity, which the transition to SONIA addresses.

How does this impact SEI portfolios?

GBP interest rate derivative (IRD) markets speedily embraced SONIA. Nearly 80% of DV01 traded in GBP referenced SONIA as reported by ISDA in November 2021. This level of adoption is key to a functioning market. Other markets have trailed this rate of adoption.

The “Fallback Rate” ensures a clear plan for transitioning these instruments.

SEI is operationally set up and has been trading financial instruments linked to SONIA across our fund range.

Where legacy contracts reference GBP LIBOR, SEI welcomes the published methodology and “Fallback Rates” and has established processes to apply these where necessary.

Important Information

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events or a guarantee of future results. Positioning and holdings are subject to change. All information as of the date indicated. There are risks involved with investing, including possible loss of principal. This information should not be relied upon by the reader as research or investment advice, (unless you have otherwise separately entered into a written agreement with SEI for the provision of investment advice) nor should it be construed as a recommendation to purchase or sell a security. The reader should consult with their financial professional for more information.

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