UK Ups the Ante on Libor Transition

The Bank of England and the Financial Conduct Authority (FCA) have redoubled their efforts to get what appears to be reluctant financial markets participants to move away from using Libor as a benchmark, citing 2020 as a “critical” year for the transition process as markets move towards the end of Libor in 2021.

In a letter to senior managers at financial institutions in the UK, the BoE and FCA state, “Although several important milestones were met last year…greater momentum is needed, and 2020 will be a key year for transition. Orderly and timely progress requires individual firms to actively engage with the wider transition efforts in the market – both those of the authorities and of industry.”

In what seems a stark warning to managers, the letter adds, “We expect to see clear evidence of this engagement from the beginning of Q1 2020.”

The UK’s Risk Free Rate Working Group, which is driving the transition has set specific targets for 2020, these include a further shift of volumes from Libor to Sonia in derivative markets, supported by a statement from the Bank and FCA encouraging a switch in the convention for sterling interest rate swaps from 2 March 2020; the cessation of issuance of cash products linked to sterling Libor by end-Q3 2020; and the significant reduction in the stock of Libor referencing contracts by Q1 2021.

The Bank and FCA are also demanding that firms take steps throughout 2020 “that demonstrate that compounded Sonia is easily accessible and usable”; and that firms consider how best to address issues relating to“tough legacy” contracts.

A document setting out the Working Group’s views on which types of business and client should use overnight Sonia, relative to alternatives including forward-looking term rates, has also been released. This concludes that use of Sonia compounded in arrears is appropriate and operationally achievable for 90% of new loans by value, which is consistent with the group’s existing expectation that the use of forward-looking term rates will be more limited than the current use of Libor. “The Bank and FCA supports this conclusion fully”, the two institutions state.

The document also includes a set of “helpful lessons learned” from recent conversions of legacy Libor contracts and a factsheet that makes clear the “whys” and “whats” of Libor transition that sets out why all market participants need to act now.

“Today’s publications…are a comprehensive suite of materials that support of the RFRWG’s priorities and milestones,” the BoE and FCA say. “The time to act is now: with the tools published today and the support of the official sector domestically and internationally, market participants have what they need to leave Libor behind.”

Although Libor was indelibly tainted by the rate fixing scandal that saw several traders go to jail, there are still questions over the suitability of overnight index rates as a suitable replacement, not least because some firms are uncomfortable with the lack of an interest rate curve and are uncertain of how to transition the large number of existing contracts that reference Libor – to the new benchmark, however the message from global regulators has been clear; the transition will take place.
Tushar Morzaria, chair of the working group on sterling risk-free reference rates, says, “2020 will be a pivotal year in the transition journey, with critical focus on enabling the flow of new business away from sterling Libor. The [working group] has therefore defined a key priority to cease issuance of sterling Libor cash products by the end of Q3. In conjunction, the RFRWG fully supports the Bank of England and FCA initiative to encourage market makers to change the market convention for sterling interest rate swaps from Libor to Sonia in Q1 2020.”
Andrew Hauser, executive director for markets at the Bank of England, adds, “Today’s suite of publications helps provide greater clarity to the market on a number of issues central to Libor transition as we head towards the 2021 deadline. I am particularly encouraged by the ambitious goals that market participants have set for themselves this year – including the aim to cease issuance of cash products linked to sterling Libor by 2020 Q3 – and by the steps already taken towards those goals, including the creation of new Sonia-linked loans and the conversion of legacy bonds. The groundwork has been laid for a decisive shift away from Libor in 2020.”
Meanwhile, Christopher Woolard, executive director of strategy and competition at the FCA, says, “In most products, market participants have made impressive progress in moving away from Libor. The time has come to draw to a close its remaining use. The Bank and the FCA have written to major banks and insurers to set out our expectations for transition progress during 2020 and to reaffirm our support for the Working Group’s targets. Firms must act now to help meet these targets and ensure a smooth transition to alternative rates by end-2021.”

The increased pressure on markets to abandon Libor comes as ISDA conducts what is its fourth consultationwith market professionals over the fallback process for the end of Ibors generally. Although there are doubts about how the transition will evolve, market sources are generally positive about the development with one senior risk manager at a bank saying, “At least we now know where we stand.”

This was also the message from Davide Barzilai, banking and finance partner at global law firm Norton Rose Fulbright, who says, “Today’s Bank of England and FCA announcement is a welcome and necessary start to 2020. While the transition away from Libor is broadly going to plan and the next two years are still available for banks to fully take the leap, today’s statements do provide clarity on areas that needed addressing.

“Prior to this announcement is was unclear how the new reference rates would fit with markets such as trade finance and Islamic finance, which have their own unique issues. As such, this announcement is timely and sets the market up with clear expectations for the coming year.”


Colin Lambert

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