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Today, the BoE announced two key initiatives aimed to further support the transition to the risk-free reference rate. These include publishing a compounded SONIA rate as well as new collateral haircuts on Libor-linked products, Pooja Kumra from TD Securities informs.

Key quotes

“These new initiatives should further encourage market participants to follow the transition timeline set by the BoE and FCA in mid-January. This timeline requires: 1. Market makers to switch the convention for GBP IRS from Libor to SONIA on 2 March 2020 2. Cease issuance of cash products linked to Libor by end Q3 20 3. Establishing a framework to reduce the stock of Libor referenced contracts by Q1 21.”

The SONIA Compounded Index will be a number representing the returns from a rolling investment earning interest each day at the SONIA rate. The compounded index value on a given day would reflect the effect of compounding SONIA across all previous business days since 23 April 2018.

“From October 2020 the Bank will begin increasing haircuts on Libor-linked collateral it lends against. Haircut add-ons on Libor Linked Collateral: 1. From October 2020: Haircut add-on will be 10% 2. From June 2021: Haircut add-on will be 40% 3. From December 2021: Haircut add-on will be 100%.”

“The FCA offers no certainty about the existence of Libor post after 2021. These requirements mark another strong step from regulators to push markets away from Libor. The urgency created by such tight deadlines should help support a smoother transition as it incentivizes participants to act sooner rather than later.”