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Inside the mortgage market’s switch from LIBOR to SONIA – Maddox

by: Alex Maddox, capital markets director of Kensington Mortgages
  • 16/09/2019
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Inside the mortgage market’s switch from LIBOR to SONIA – Maddox
The series of benchmark interest rates known as the London Interbank Offered Rate (LIBOR) has acted for decades as the main reference rate for financial products globally, including loans, derivatives and bonds.


It’s based on the average at which large global banks would lend funds to each other and is commonly calculated in seven maturities across five currencies.

Discussions about finding a replacement rate have continued for several years, driven largely by the controversy that ignited when it emerged that LIBOR had been manipulated by several banks.

The scandal came to light fully in 2012. By 2018, the Financial Conduct Authority (FCA) confirmed that LIBOR would be phased out by the end of 2021. The regulator asked market participants to begin considering how they would transition to a new rate.

The big question that emerged was ‘what should the new reference rate be?’ Hundreds of trillions of pounds of financial assets around the world are linked to LIBOR and many legacy contracts do not provide for what happens if the benchmark ceases to be published.


Investors well prepared

The Sterling Overnight Index Average (SONIA) was put forward as a replacement for LIBOR.

SONIA differs from LIBOR in a number of ways. It is based on actual transactions and is not set, currently, in different maturities. SONIA reflects the actual average interest rates that banks pay to borrow sterling overnight from other institutions, unlike LIBOR which is forward looking.

The first SONIA-linked Residential Mortgage Backed Security (RMBS) issued in the UK was Principality’s Friary No. 5 deal in March 2019, although the full £523m transaction was retained. 

We finally saw a publicly-placed RMBS in April, with Nationwide’s Silverstone 2019-1 securitisation, which saw investors buy £750m of SONIA-linked bonds (in addition to a $350m US LIBOR-linked tranche). 

One transaction was all that was needed for the shift to be cemented. Since then, nine out of the 10 new RMBS issued backed by new collateral have been SONIA-linked. 

At Kensington, we issued our first SONIA-linked transaction in July 2019 through the Finsbury Square programme. 

At the start of the summer a number of large investors were still not in a position to invest in SONIA-linked issuances, but this had shifted quickly over the course of a few months.

We found that most investors were comfortable with the new benchmark for RMBS. They had prepared their systems and processes in the lead-up to issuances kicking off in May and June and they were ready for the switch.

The transition away from LIBOR appears to be well on-track on the primary issuance side. This is promising for transitioning legacy instruments that are linked to LIBOR, a process that’s expected to be more complex.


Change in calculations, not rates

Some mortgage customers may also be impacted by this change. A number of lenders, including Kensington, have reversionary rates which are tied to LIBOR, which will need to be replaced by a new benchmark.

Some institutions are moving to the Bank of England (BoE) base rate with which customers are generally familiar.

SONIA is also a feasible alternative and is particularly attractive to lenders that rely on capital markets for funding because it will enable them to manage asset and liability mismatch risk. 

The expectation is that the margin over benchmark will be adjusted such that the total rate paid by the customer does not change, whichever option lenders choose.

Therefore the transition from LIBOR should, in practice, represent a change in the calculation of customers’ mortgage rate, rather than a change in the rate itself. 


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