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Libor Transition Plans Requested by UK Regulators – FCA/PRA

Libor Transition Plans Requested by UK Regulators – FCA/PRA

(19 September 2018 - UK) UK authorities are striving to transition financial markets away from the discredited London Interbank Overnight Rate (Libor) interest rate benchmark. 

Regulators have propositioned CEOs of major banks and insurers to share their detailed plans for moving to alternative rates. The Financial Conduct Authority (FCA) announced in 2017 that from 2021 onwards it would no longer force banks to provide a daily rate. Since then the industry has been relatively slow to react. While fragmentation at both region and product-level is expected, market participants are realising that a consistent approach is needed to ensure a smooth transition for linked products. JPMorgan and Morgan Stanley were among the UK-supervised institutions to receive a letter this week from the FCA and Prudential Regulation Authority (PRA) seeking detailed risk assessments for their Libor exposures. City regulators are trying to gradually push the financial system off Libor, an interest rate underpinning up to $170 trillion in interest rate swaps, mortgages, consumer loans and credit card rates but which in recent years has been tarnished by a series of manipulation scandals. Many Libor users such as loan and mortgage companies have been reluctant to move from the rate as it offers stable and predictable payments, raising fears about the risks to financial stability if a replacement is not widely used by 2021. The companies have until December 14 to submit a board-approved summary of their Libor-related risks and details of plans to mitigate them. Institutions also have to identify the senior managers tasked with overseeing the implementation of transition plans. “The purpose of the letter is to seek assurance that firms’ senior managers and boards understand the risks associated with this transition,” the regulators said in a statement.

As banks kick off the pressing task of revising thousands of contracts based on Libor, the need for a financial market-wide approach is becoming clear. Issues are emerging over the International Swaps and Derivatives Association (Isda) impact, the effect on loans and accounting processes. A large portion of the derivatives market is made up of corporates and other borrowers hedging an exposure, be it via loan, bond or other instrument altogether – so those two products must be backed by the same interest rate. While the FCA will no longer require banks to submit rates that are used in compiling Libor after 2021, it is leaving it up to banks and their customers to move to a new interest rate benchmark rate rather than mandating them to do so. “It’s like legislating but using supervisory powers instead of common law,” said Alex McDonald, Evia CEO, a trade association that represents London’s brokers and trading venues. Not all banks have received letters but the agencies urged all institutions that rely on Libor “to read and reflect on this letter”. Regulators want a rate based on frequent transactions and one that does not require a component that assesses bank creditworthiness, as Libor does. In April, the UK began publishing an alternative sterling benchmark that was a reformation of an overnight rate called Sonia; it is based on transactions.

“The implicit threat in here is; ‘if you don’t provide us with this, we will add on a big risk charge to your capital costs” said Andrew Bailey, FCA CEO, who has led the push for the market to find an alternative to Libor which sets the cost of unsecured borrowing for a variety of periods, usually over one, three and six months. “Whether it’s a derivative or a corporate loan, we’re working incredibly hard with clients and industry bodies to develop the fallback language we use for legacy contracts referencing Libor – it’s helped by the fact Sofr and Sonia are the clear new reference rates in the US and UK and just last week the working group on euro risk-free rates recommended Ester, though some other jurisdictions are a bit further behind,” said Marco Petta, managing director and head of transformation and strategy at RBC Capital Markets in Toronto. “There’s significant work to be done as we approach 2021, but not all of this can fully begin yet.”

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