On 09th March 2020, the Financial Conduct Authority (FCA) and Bank of England published a statement regarding how the discontinuation of LIBOR may affect members and stakeholders.
On February, the Financial Conduct Authority (FCA) informed asset management firms in the UK regarding transition from the interest rate benchmark LIBOR to alternative ‘risk-free’ rates
LIBOR Ending
The LIBOR benchmark relies on estimates from banks of their borrowing costs in markets which are no longer active, so is not considered sufficiently robust or sustainable given its widespread use. Continuing to rely on LIBOR after this point will create a number of risks to firms. One of these is a lack of clarity over the legal position and interest payments due for contracts that refer to LIBOR rates.
The process of transition in the UK is being overseen by the Working Group on Sterling Risk-Free Reference Rates (RFRWG). The RFRWG was convened by the Bank of England and FCA and is made up of a wide range of firms including banks, asset managers, non-financial corporates, trade bodies and professional services firms.
The FCA has secured agreement from banks that will keep contributing to LIBOR until the end of 2021. This will give users time to switch to alternative rates before LIBOR is discontinued.
Alternatives
There are a number of alternatives to LIBOR already in wide use. In particular, in 2017, the RFRWG chose the Sterling Overnight Index Average (SONIA), published by the Bank of England, as the preferred risk-free rate for wholesale financial markets in the UK. SONIA is based on transactions that firms report to the Bank of England. It reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions. For more information see the Bank of England website. An RFRWG Task Force of both lenders and borrowers have concluded that SONIA is suitable for use in around 90% of future sterling lending by value. Other alternative reference rates are also available, including fixed rates or the Bank of England’s policy rate (Bank Rate). Further information can be found in The Use Cases of Benchmark Rates, published by the RFRWG in January 2020.
Key dates
With less than two years until end-2021, this year is the critical year for firms to take action to identify and remove any dependencies on LIBOR. The RFRWG has set a target date of end-September 2020 for banks and other lenders to stop making new LIBOR-based loans that mature beyond end-2021. This is to protect borrowers from uncertainty about their future interest payments that would occur if their lenders were still using LIBOR beyond that date.
There is more information on LIBOR transition in this factsheet, published by the RFRWG.