RBC Capital Markets blazes trail on risk-free rates bond issuance

From left: Peter Riera, Carole Ly-Marin, James Taunton, Anthony Tobin, Sean Taor

The move away from London Interbank Offered Rate (Libor) to alternative risk-free rate (RFR) benchmarks such as Sterling Overnight Index Average (Sonia) continues to accelerate, at least in the bond markets.

This year saw the launch of the first Sonia-linked floating rate note to use a ‘shift’ rather than a ‘lag’ weighting methodology. That has important implications for indexation, which simplifies the calculation of compounded interest rates and is also more consistent with evolving international practice. RBC Capital Markets was a joint bookrunner on the issue – the bank tops Bloomberg’s rankings for all sterling Sonia bond issuance from 2018 to the present.

One distinguishing feature of RBC’s debt capital markets (DCM) team is its market-facing nature. “We are very much a part of the markets,” says Sean Taor, RBC head of DCM Europe. Chinese walls notwithstanding, DCM origination and syndicate sits within fixed income, currencies and commodities, and shares revenues with sales and trading, he adds.

Leading the charge

The bank made a conscious decision to be at the forefront in the evolution of the new reference rates. Though Sonia had been around since 1997, it had struggled to make any headway against Libor until 2017, when the Financial Conduct Authority, the UK regulator, indicated it would not support the latter after the end of 2021.

“That was a turning point, and it was clear that nothing would be the same going forward,” Mr Taor recalls. From then on, he says, the bank mobilised all its internal resources, as an issuer, underwriter, trader and investor, to support the development of new RFRs.

It already had a track record with Sonia, having led the very first Sonia-linked bond issue. This four-year £300m ($376m) deal was undertaken by the European Investment Bank (EIB) in 2010, with RBC as sole lead manager. “It didn't take off,” says Mr Taor. “Many investors were unable to book a Sonia transaction because there were no systems, so it was a challenge. Perhaps the transaction was ahead of its time, but we learned from it.”

RBC was joint bookrunner, with NatWest Markets, HSBC and TD Securities, on the EIB's next Sonia-linked milestone, a £1bn deal launched in June 2018. This attracted some £1.55bn of demand.

By now, as Mr Taor puts it, the plumbing was in place and investors were rather more receptive, even though structurally not much had changed. “About 90% of the documentation of the 2010 transaction is still the documentation of today, so that deal was a template,” he says.

Driving role

RBC has been a key player in developing this market. It has worked with the regulatory authorities, serving on the Bank of England’s Sonia stakeholder advisory group and the RFR bond market subgroup. That has fed into its dialogue with clients. “After 2018, we were out there communicating with our clients, explaining what a Sonia transaction would mean to them,” says Peter Riera, RBC head of European financial institutions group DCM. “Because the team is so close to markets, we were able to cross-pollinate ideas.”

Since then, RBC has led 19 inaugural Sonia deals, more than any other bank. They included a £750m three-year deal for Lloyds Bank, the first from a UK high street bank, in September 2018. That was followed almost immediately by a £1bn three-year deal from Santander UK.

RBC was also a joint bookrunner on ANZ’s £750m three-year transaction in January 2019, the first from a non-UK bank. “It is natural for UK banks to want to please the UK regulator,” says Anthony Tobin, RBC European head of DCM syndicate and frequent borrower origination. “It is less natural for international issuers to want to do the same. But such was the strength of the development of Sonia that they too have been coming to the sterling market.”

In September 2019, RBC issued its own £1bn five-year Sonia-linked covered bond, the first in that maturity from a non-UK issuer and the bank’s first term RFR issue globally. “We have also been bringing longer maturities to market, including the first seven-year transaction for a financial institution,” says Carole Ly-Marin, an RBC associate in DCM origination. That was Santander’s £1bn seven-year covered bond, issued in February 2020.

“The Sonia investor universe has grown over this period from about 50 in 2018 to more than 240 today,” says James Taunton, director in DCM at RBC Capital Markets. "By February 2020, more than 120 Sonia-linked deals worth over £57bn had come to market, all using the so-called interest period lag methodology to calculate interest payments.”

US replacement

In the US, US Libor is now being replaced by the Secured Overnight Financing Rate (SOFR), and February saw the introduction of a SOFR index, using an ‘observation period shift’ methodology. The difference between the two approaches is in the weighting of the rate according to a specified number of business days before the ‘business day’ in the interest period.

Having an index standardises and simplifies the calculation method for RFR-linked instruments. “But you can’t use one index with all lag deals,” says Mr Riera. “So there has been a lot of discussion about the need for the Sonia market to evolve.”

The Bank of England now says it will publish a daily Sonia Compounded Index from July 2020. The first Sonia-linked floating rate note to use the shift methodology was issued by the European Bank for Reconstruction and Development (EBRD) in February 2020.

The three-year deal attracted orders of £1.85bn from 60 investors, the second largest sovereigns, supranational and agencies Sonia order book ever. The deal was upsized to £750m, making it the EBRD’s largest ever sterling bond, and the spread tightened by 2 basis points (bps) to 25bps. RBC was a joint bookrunner, alongside Barclays, HSBC and NatWest Markets.

Shortly afterwards, RBC was joint lead manager and structuring adviser on the first SOFR-linked bond. Other leads were TD Securities (also a structuring adviser), Citi, HSBC and Standard Chartered. The issuer of the no-grow $1bn benchmark deal was the EIB, and initial price thoughts were SOFR plus 29bps.

Demand exceeded $1.6bn and the reoffer spread was set at 28bps. Europe, Middle East and Africa investors took 71% of the deal with 27% going to the Americas, and banks and bank treasuries accounted for 75% of the allocation.

New euro rate

The EIB had already stepped up to the plate to get the euro’s new RFR under way. In October 2019, it issued the first ever benchmark to reference the Euro short-term rate (€STR). After an extended marketing period to boost the number of participating investors, the transaction was announced with price thoughts of €STR plus 12bps.

With final demand of more than €2bn, the reoffer spread was fixed at 11bps in a €1bn three-year deal. France took 35%, followed by UK (27%), the Benelux region (15%) and Scandinavia (10%). Germany/Austria was less eager, taking 3%. Banks and financial institutions accounted for 71%.

In January 2020, the EIB followed up with a second €STR transaction, mirroring the first – a €1bn three-year deal with a 11bps spread. Demand was €1.6bn. RBC was a joint lead on both deals, and the only bookrunner to have been on every one of the EIB’s RFR deals so far – Sonia, €STR and SOFR.

The DCM team has worked closely with RBC’s derivatives team to offer clients derivatives capacity across Sonia, SOFR and €STR. “It would be rather pointless to issue in Sonia-linked form and then swap the funds back to Libor,” says Mr Tobin.

The RFR market, and Sonia in particular, has come a long way, very quickly, according to Mr Taor. “Two years ago many bank investors doubted whether this would happen, but no one questions it now. Sonia-linked bonds now account for 25% of all sterling issuance,” he says. While SOFR has made strides in the commercial paper market, it is still a work in progress in the term market (maturities of two years or more), adds Mr Taor.

In DCM, Sonia has been the first market to evolve away from Libor, according to Mr Riera. “Sonia will help the market continue to develop,” he adds. “The next step will be to see a broader take-up of Sonia outside the bond market – in the loan market, perhaps?”