Although referenced in the appendix below, the Sterling Working Group monthly newsletter is a really handy one-pager (covering all currencies) – definitely worth signing up for.
Synthetic LIBOR is a bridge, not an endpoint
In GBP markets possibly the most material development in recent days is the announcement and consultation issued by the FCA on 29 September relating to synthetic LIBOR.
In it, the FCA is confirming that, to avoid disruption to legacy contracts that reference the 1-, 3- and 6-month sterling and Japanese yen LIBOR settings, it will require the LIBOR benchmark administrator to publish these settings under a 'synthetic' methodology, based on term risk-free rates, for the duration of 2022. These 6 LIBOR settings will be available only for use in some legacy contracts and are not for use in new business.
The FCA will decide and specify before year-end which legacy contracts are permitted to use these synthetic LIBOR rates. But, at least for the duration of 2022, the FCA is proposing to permit legacy use of synthetic sterling and Japanese yen LIBOR in all contracts except cleared derivatives.
The FCA has published a consultation on its proposed decision which is open for responses until 20 October.
However, before you put your feet up for a rest, believing that this has effectively pushed the issue of LIBOR transition down the road to the end of next year, it’s worth considering:
- Will your existing contracts actually fall back to synthetic LIBOR – or do they revert to something else – such as fixed rate?
- Does negotiating a fallback to synthetic LIBOR effectively mean you have to renegotiate everything twice – it may be more straightforward just to ‘get it done’ and move to an alternate reference rate.
- Synthetic LIBOR is not a long-term solution, it may give you longer to transition, but transitioning will still be necessary (unless perhaps your contract matures in 2022).
- Synthetic LIBOR may not be the cheapest solution – look carefully at how your counterparty will be calculating it – under FCA guidance, there’s a credit adjustment spread that will be added to the rate in order for it to more closely mirror legacy LIBOR.
- If you have hedges in place, it becomes even more complex to ensure everything stays aligned for hedge accounting purposes.
I’m sure there are many other considerations, but to summarize, in order to ensure certainty, it’s almost certainly preferable to push on with active transition (and yes, you can actively transition at any time – we’ve heard of one bank that assumed that because the corporate hadn’t transitioned by the end of September, they wouldn’t want to until the end of 2022…)
Progress in the USD market
Whilst it is still early days, it appears as though Term SOFR was the solution the market was waiting for as the replacement for USD LIBOR in loans (the American market being very different to the UK). The scale and liquidity of the USD market means that a Term SOFR will likely be more robust than a Term SONIA but the greatest liquidity (and sharpest pricing) will be in the overnight markets in both cases.
Also in the last month, Gary Gensler, Chair of the US SEC, spoke about the desirability of adopting credit-sensitive rates – read the speech here.
Finally, reverting to the FCA consultation, in the case of the 5 US dollar LIBOR settings that will continue in their current form until mid-2023, the FCA’s consultation also sets out its proposed decision for restricting new use of these LIBOR settings after end-2021, in line with existing US supervisory guidance. That means that broadly speaking USD LIBOR will not be available for use in new contracts after the end of this year.
Indices
Indices may or may not be a suitable solution for your organisation, but if they are, it’s worth noting that, as mentioned a couple of weeks ago in the general newsletter, the IBA have added Risk-Free Rate Indexes for USD, Euro and JPY to their existing offering of a GBP index.
ICE RFR Indexes have been developed to support the lending market as it transitions to RFRs by standardizing the calculation of interest for financial contracts and providing pre-calculated compound interest values for each business day and you can find further information on their website.
Breaking News
Whilst it may not affect you directly, the replacement rates for Swiss Franc (CHF) LIBOR and EONIA will be discussed in mid-October between the European Commission (EC) and Member States.
It appears that there have been some issues identified linked to the replacement rates for CHF LIBOR resulting in pushback from Polish consumers who have been asking for an option to obtain a more favourable rate than currently proposed by the EC. (interestingly, there’s a large number of mortgages in Poland borrowed against CHF…)
The influx of consumer input has prompted the EC to be more cautious ahead of its adoption, notably by requesting more expert input. To this end, the Expert Group of the European Securities Committee (EGESC) is scheduled to discuss the state of play of this adoption during their next meeting on 15 October.
Should there be any issues from your perspective on the replacement rates proposed by the EC, now would be a good opportunity to voice them.
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Appendix
We are going to include this appendix each month as a quick reference for useful sources:
For the latest markets data, we’d recommend ‘going to the source’, so the RFR WG in the UK; the ARRC in the USA etc.
By currency, the ‘source’ information comes from:
GBP: Risk-Free Rate Working Group (RFR WG)
USD: Alternate Reference Rates Committee (ARRC)
JPY: The Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks
CHF: The National Working Group on Swiss Franc Reference Rates
EUR: Working group on EURO risk-free rates
SGD: Steering Committee for SOR & SIBOR Transition to SORA (SC-STS)
The RFRWG also publishes a monthly newsletter offering a one-page summary of the latest developments. Sign up to receive it monthly - the latest (September) version is here.
If you are looking for suggested ways of approaching the transition project, the ACT website has resources.
Other useful resources include relationship banks, advisers, trade associations such as UK Finance and the FICC Markets Standards Board (FMSB).