This article looks at some of the trends we have seen in the use of interest rate benchmarks in the mid-market since the cessation of LIBOR, with a focus on sterling loans in the UK mid-market.

We said a final goodbye to sterling LIBOR over a year ago, and in that time our team has acted on over £2bn worth of facilities. As we look back on the last 12 months’ worth of transactions, some trends are emerging.

Where we are now

Synthetic three month LIBOR for sterling is available until March 2024 to help deal with ‘tough legacy’ loans (the other tenors ceased 31 March 2023). USD is the only LIBOR rate still being published based on bank submissions; that will cease in June with limited tenors remaining available on a synthetic basis until September 2024 to deal with tough legacy loans.

What we’re seeing

In the sterling market we’re on the other side of what once felt like an impossible task and in this new world, we’re seeing some patterns in the use of benchmarks emerge:

• Syndicated facilities have largely been using SONIA and SOFR in place of GBP and USD LIBOR respectively, as expected and in line with relevant working group recommendations;
• In the UK, compounded SONIA and SOFR are typically being used, with some use of their term equivalents (particularly SOFR – see below). Agent banks are largely settled on their calculation requirements; around use and length of observation shifts, daily rate rounding, market disruption and zero floor preferences. There’s typically no requirement for break costs, but limits on frequency of prepayments are often imposed to keep day to day management of the loan under control;
• We’re seeing a decline in the use of the credit adjustment spread (‘CAS’). Loans priced on SONIA at term sheet stage have wrapped the spread up in pricing, leaving no need for a CAS. Despite it initially being a contentious concept, CAS is therefore largely limited to featuring in loans which have switched from LIBOR to SONIA mid term.
• The US market has taken a slightly different approach and gravitated towards the use of term rather than compounded SOFR. Term SOFR is a forward looking rate which uses straightforward calculations to create projections and crucially, those calculations can be made at the start of an interest period (unlike the compounded rates which can only be calculated towards the end).
• Term SOFR is popular for the reasons outlined above and in addition has been more widely accepted by US regulators than term rates have been here in the UK. That said, its appropriateness and impact on financial stability is under constant review.
• Where term SOFR has been included on our transactions it’s generally been in USD only facilities and use of term SONIA has generally been on bilateral transactions. However, with the Loan Market Association (‘LMA’) documents now providing for a combination of term and compounded rates, these trends may be quick to change, particularly as awareness of term SOFR increases.
• On ABL (and some bilateral transactions) there has been a clear shift towards a preference for base rate. Base rate provided a safe port in the rate switch storm, but again this may be a trend which disappears as the dust settles on IBOR transition, though we have seen no evidence of that to date.
• With no current plan to cease EURIBOR we haven’t seen much change in its use – the LMA documents still cater for EURIBOR to be used throughout the term (albeit with an option to include a future switch to €STR).

The future

To date, the clearing banks have been more likely to reference compounded SONIA than other lenders. They’ve worked tirelessly in recent years to ensure they were aligned with working group recommendations and establish the infrastructure needed for the switch.

The use of term SOFR in the UK market is gathering momentum, as it has in the US. With the LMA documents now providing additional flexibility, providing a combination of term and compounded rates becomes a lot simpler from a drafting perspective, and it seems likely we will more regularly see a mix of compounded SONIA alongside term SOFR and EURIBOR.

As more and more lenders finalise their RFR calculation preferences and processes, and borrowers become more familiar with SONIA, we expect that base rate linked loans will decline; their use has been largely limited to ABL and bilateral facilities. Bilateral facilities often follow the trends of the syndicated loan market, which is now confident in using compounded SONIA which is after all ‘risk free’ and ultimately, just an average.