The move to the use of overnight benchmarks as the main interest rate benchmarks is progressing. After the wave of new overnight-linked futures in the last months by CME, ICE and CurveGlobal, we now have a large overnight-linked bond issuance. The EIB has successfully issued a one billion 5-year SONIA-linked bond.
The coupon payment is based on the backward-looking overnight SONIA composition plus a spread of 35 basis points (Maturity 2023-06-29, quarterly payments, ISIN XS1848770407). Note that a small 2 millions bond had been issued in January (quarterly SONIA + 25 bps, maturity 2023-03-20, ISIN XS1889459713). Thanks to an acute observer of the market for pointing that to me.
Backward-looking overnight is viable. Certainly for some issuers and investors. There was never a doubt about it for some market participants. This does not prove it is viable for all market participants, and this is where the question lies. Note that the coupon will be paid with a five-day lag after the last overnight benchmark fixing. This is a serious discrepancy with the current overnight-linked derivative market which pays with a zero day lag in Sterling (and 2 in EUR and USD). Some elements of the issuance are discussed in a Risk article 'EIB shrugs off term RFR worries with Sonia bond plan' (subscription required) and a Financial Times article 'EIB to offer Libor alternative with Sonia-based bond' (subscription required).
The question of backward-looking or forward-looking — i.e. OIS benchmark — overnight-linked coupons is heavily discussed in the potential LIBOR discontinuation and fallback provisions. The EIB issuance, even if linked to backward-looking overnight benchmark, does not bring any substantial positive information regarding the fallback discussion. If anything, the five-day lag expresses the difficulty of that approach. The backward looking payments have been used for many years in the derivatives market and there is not doubt that they are working for products designed with its requirements in mind.
Regarding the LIBOR fallback, the products linked to LIBOR have been designed with the term rate at their core. Can we replace a term rate by a backward-looking rate? That is the question. The answer is: in some case yes and in some cases no. The obvious 'no' are FRA with FRA discounting settlement and LIBOR in-arrear that require a payment at the start of the term period. As the fallback procedure should be the same for all LIBOR usages in derivatives, the global answer to the fallback procedure question has to be 'no, a backward-looking fallback is not possible'. The above answer is not only a personal opinion, it is a physical impossibility, except if one can realize backward time travel.
I will provide more technical details and opinions about the LIBOR fallback in a forthcoming notes. Hopefully I will have time to finish it by mid-July.