“Whether it is some form of active conversion, or use of fallbacks, you need to make an informed decision on when and how to transition your contracts”.
Edwin Schooling Latter, Director of Markets and Wholesale Policy, FCA
As you will be aware, GBP LIBOR transition needs to have been completed by the end of the year (and ideally by the end of September to manage the very real risk of resource constraints in Q4).
With less than 6 months to go before most LIBOR panels come to an end, there has been a flurry of activity encouraging market participants to get across the finishing line ahead of the end of the year.
A Risk-Free Rates Working Group (RFR WG) note on transition of loans: ‘Active transition of legacy GBP LIBOR loan contracts – Timelines and considerations for borrowers’ RFR WG July 2021 - Active transition of legacy GBP LIBOR loan contracts
A helpful piece from Nat West when considering the importance of actively transitioning – and to go about it. LIBOR transition: Act now or fall back?
A UK Finance micro site designed or SMEs but of value and helpful to all corporates: UKF SME LIBOR Resources (Consider sharing this though your supply chain – nobody needs any more nasty surprises after the last 18 months…)
A speech from Edwin Schooling Latter of the FCA, which whilst principally targeted at regulated firms, is important or all market participants. The highlights follow but you can read the speech in full here.
With regards to the, as yet undefined, ‘tough legacy’ and use of synthetic LIBOR after the end on 2021, regulated counterparties (whether that’s banks or asset managers/ bond holders) will be under considerable pressure from the FCA not to use synthetic LIBOR, For example, although consent solicitation can be near impossible, conversion of legacy bonds may be possible in some cases: the Investment Association have provided this useful note: Encouraging Transition of LIBOR Linked Bonds.
The vast majority of the derivatives market will have converted to SONIA and SOFR when the LIBOR panels end. It’s clear where swap market liquidity will end up, and even six months before the end of the sterling LIBOR panel, close to three quarters of new cleared sterling swap activity is now based on SONIA.
In sterling markets – where LIBOR used to be deeply embedded – liquidity has moved from LIBOR to overnight SONIA. That happened first in bonds. Then in securitisations. Then in linear swaps. Then in loans. Then in non-linear OTC derivatives. It turns out that most of those products did not need forward-looking rates. Overnight rates, compounded over the interest period, worked well.
In the cash market, bonds have been the pacesetter. New issuance in [sterling] bond markets has been based almost exclusively on SONIA since 2019. And we have now seen a little over 1/3 of outstanding sterling LIBOR bonds – by value – converted, through consent solicitations, to overnight SONIA compounded in arrears.
Loans were slower off the mark, but the shift to overnight SONIA has been decisive – following the Working Group on Sterling Risk-Free Reference Rates' (RFR) end-Q1 milestone to stop new business based on LIBOR.
While the FCA is also taking steps to provide a time limited safety net to help contracts that can’t be transitioned, this does not remove the need for firms to act.
Certain, yet to be determined ‘tough legacy’ contracts will be allowed to use a synthetic LIBOR rate based on forward-looking term RFRs, so SONIA for sterling, plus the relevant ISDA spread adjustment.
The end-Q3 date is there for a good reason. It will help avoid risks of getting caught in a pre-Christmas rush – where we could see a squeeze in IT, legal or other resources, or would simply have too little time to adjust to unexpected hurdles.
There are good reasons why you might choose for the actual change of rates payable to take effect only at the end of 2021, particularly for example if using SONIA plus the ISDA spread as the future rate. But we encourage you to put in place plans that mean arrangements for this change have been completed in good time, in line with the Q3 milestone.
Whether it is some form of active conversion, or use of fallbacks, you need to make an informed decision on when and how to transition your contracts. There is a lot of information out there to help you make those decisions – on the FCA, Bank of England and RFR Working Group websites, and through your trade bodies and advisors. But our key message is that you really need to have your active conversion plans in place in the next 3 months.