FCA has no plans to compel banks to join or rejoin LIBOR panels after end-2021

Shortly after the UK Financial Conduct Authority (FCA) warned that it would monitor whether firms treat customers fairly when replacing LIBOR, the regulator has outlined the next steps in transitioning away from LIBOR. In a speech delivered today Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, focused on these key steps.

In sterling swaps and loan markets, sterling LIBOR public bond issuance appears to have ceased, he noted. But in sterling, as well as in US dollar, Japanese yen and Swiss francs, significant volumes of new LIBOR swaps maturing after end-2021 are still being struck.

In sterling IRS (interest rate swap) markets, the FCA will be encouraging market makers to make SONIA the market convention from the first quarter of 2020. This means making it standard to quote and offer swaps based on SONIA rather than LIBOR.

In the loan market, however, the task ahead is a bigger one. Use of LIBOR is rare in new mortgages. It is getting even rarer as the handful of smaller lenders still using LIBOR have completed, or near completion of their transition programs. Alternatives, including both fixed rates and alternative variable rates are already widely used. One of these is Bank rate (which past data show SONIA to have tracked closely).

Regarding global derivatives markets, moving away from LIBOR altogether is likely to be the best way of avoiding LIBOR risks, Mr Latter said. But another important safety belt is ensuring that contracts that rely on LIBOR have clear fall backs that deal effectively with the prospective end of LIBOR. This is valid especially for the swaps market, given the sheer size of exposures.

At this stage, Mr Latter admitted, the FCA does not know precisely how the LIBOR ‘end-game’ will play out. It may be that for all 35 LIBOR currency-tenor pairs a final cessation date can be announced comfortably in advance, and transition away from each of these rates can be substantially completed in an orderly manner before then.

The FCA has warned that firms must not assume LIBOR will continue beyond end-2021 even if transition is not substantially complete.

But another possible variation of the end-game is that LIBOR’s final cessation is preceded by a period in which it is still published but no longer passes the key regulatory test of being capable of measuring the underlying market or economic reality. In other words the benchmark is no longer ‘representative’. The most obvious reason for failing this test would be the departure of panel banks.

If LIBOR becomes unrepresentative, this would be an irreversible step towards the end of panel bank LIBOR. The FCA does not plan to compel banks to join or rejoin LIBOR panels after end-2021. The regulator has already made our agreement with the panel banks. In any case, the more obvious time to use a panel bank compulsion tool would be before the rate became unrepresentative rather than afterwards.

“Let me repeat that the best way to avoid LIBOR-related risks is to move off LIBOR altogether”, Mr Latter concluded.

Lenders and borrowers using SONIA or other variable rates, or fixed rates, will not face LIBOR risks. Banks and asset managers with SONIA or SOFR swaps and futures will not face these risks. But for those not quite ready to make this move to SONIA, SOFR or equivalents yet, contractual fall backs offer a safety net.