BACKGROUND
On 5 July 2021, Edwin Schooling Latter, the Director of Markets and Wholesale Policy at the Financial Conduct Authority (the “FCA”) gave a speech on the transition from the London Interbank Offered Rate (“LIBOR”), which was first raised by Andrew Bailey four years ago.
WHAT IS LIBOR?
LIBOR is a benchmark interest rate used by banks all over the world to make short-term loans to one another within the international interbank market. LIBOR is set daily by the Intercontinental Exchange (“ICE”). ICE gathers the sum of the interest rates of all the major global banks at which they charge for short-term loans, save for the highest and the lowest rates. It takes the average of the sum, which becomes the daily LIBOR.
UK TRANSITION FROM LIBOR TO OVERNIGHT RATES
In his speech, Schooling Latter stated that the challenges contemplated as a result of the transition from LIBOR to overnight Sterling Overnight Index Average (“SONIA”) in the sterling markets, have been steadily overcome. First in bonds, then in securitisation and linear swaps, before loans and non-linear OTC derivatives adopted this change. The SONIA has proved to work well, if not better than LIBOR. Schooling Latter emphasised the importance of ensuring all legacy contracts that are capable of being converted, should be converted by year end. However, the FCA has been granted new powers by Parliament to assist in facilitating the continuity of those legacy contracts that are not convertible.
Schooling Latter further urged market participants to make an informed decision on the time and ways in which they transition their contracts. As such, active conversations need to be carried out by such market participants in the next three months.
US DOLLAR MARKET TRANSITION
The US dollar panel has slightly longer to transition, until the end of June 2023. The US authorities have already published guidance on the termination of the use of US dollar LIBOR in new contracts by the end of 2021. This guidance applies across all asset classes. As such, market participants are strongly encouraged to take steps to move any new US dollar interest rates business to the secured overnight financing rate (“SOFR”).
It should be borne in mind that interdealer brokers have been asked to replace US dollar LIBOR linear swaps with SOFR swaps from 26 July 2021 onwards, which is known as the ‘SOFR-first’ initiative. This initiative is fully supported by both the FCA and the Bank of England. This is anticipated to be a valuable step towards achieving the deadline for the discontinuity of US dollar LIBOR.
NEXT STEPS
A Working Group on Sterling Risk-Free Reference Rates’ milestone for progress is set to take place at the end of Q3 2021. The FCA is still awaiting confirmation on its final decision on the permitted users of these new rates in Q4 before publishing a final policy once the feedback has been considered.
In the meantime, market participants are encouraged to amend contracts where possible and as soon as possible. It is not necessary to wait for the FCA’s decision on synthetic LIBOR, a methodology used to achieve a fair and reasonable approximation of the expected value of the LIBOR benchmark, before beginning such amendments.
To review the FCA’s speech on the LIBOR transition, please click here.
For more information, and any guidance or advice on the LIBOR transition and how to amend your contracts accordingly, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.
