The minutes of July’s Sterling working group on RFRs were published yesterday and they contain a warning for UK regulated banks not to use a bank credit-sensitive rate such as the Bloomberg Short-term Bank Yield rate (BSBY) without first speaking to their FCA supervisor. Why? The reasons are to some extent the inverse of why regional US bankers want to use them, but there is more to it, and a speech by the Bank of England’s (BOE) Edwin Schooling Latter of 5 July explains why both the BOE and the Federal Reserve want Secured Overnight Financing Rate (SOFR) to be used. Credit sensitive rates pass on to the borrower the consequences of banks having to pay more for money – see further ”We’re bankers – we’re special” from 30 April, but that was true of LIBOR too. But there is another reason. These rates are derived largely from transactions in CP and CD markets, and liquidity in these markets has not proved robust to stress. In March 2020, liquidity in CP markets dried up. In February 2020, the spread over SOFR had been about 14 bp (as it is now roughly) but in late March it spiked:
- LIBOR - 140 bp over
- BSBY - 120 bp over
- ICE Bank Yield Index - 154 bp over
This liquidity squeeze did not happen in the markets supporting SOFR and SONIA. So, rates like BSBY (but not AMERIBOR - this is produced in a different way) and not just sensitive to bank credit risk, but also to liquidity risk. The points for finance lawyers to note are:
- if our borrower client’s lenders are proposing to use BSBY, they are asking the borrower to take on both these risks, and borrowers would be unwise to agree - certainly they would unless they were happy they were getting some proportionate benefit in return for the risks (which most of them would be unable to assess properly too);
- if our lender client is FCA-regulated, the FCA does not see them as suitable for less sophisticated borrowers who might not understand the complex and relatively opaque risks they present.
If you have a UK or European-led deal with significant US regional bank involvement, there could be some interesting debates at the pre-syndication stage between the UK and US lenders being courted to come into the deal.