The Bank of England and Financial Conduct Authority (FCA) have fired a warning shot at the financial services sector over slow-moving transitions away from Libor-based contracts, saying that “greater momentum” is needed by the sector to ensure it can move away from Libor completely by the end of 2021.
The comments came as the two published their priorities and an updated roadmap for firms moving away from the legacy benchmark this year.
(Libor is a measure of the average rate at which banks are willing to borrow wholesale, unsecured funds. It underpins financial contracts worth trillions, but as the way banks fund themselves has changed, very few transactions are actually made in the underlying market that Libor measures, and it is being phased out).
Libor Transitions: Supervisory Tools “Under Review”
The BoE’s wrote to firms late last week, saying: “The FPC (Financial Policy Committee) will keep the potential use of supervisory tools under review in light of transition progress made by firms. As they have made clear, ‘The intention is that sterling LIBOR will cease to exist after the end of 2021. No firm should plan otherwise'”.
The reference interest rate remains embedded in millions of financial contracts. The central bank wants an end to the issuance of cash products linked to sterling LIBOR by the end of Q3 this year, but has work to do getting banks to meet its deadlines.
(Regulators say a 2020 priority is “establishing a framework for the transition of legacy LIBOR products… to significantly reduce the stock of LIBOR referencing contracts by Q1 2021; and considering how best to address issues of ‘tough legacy’ contracts.)
End of LIBOR: New FCA Guidance
As Genpact’s Anu Sachdeva told Computer Business Review last year: “The volume of the contracts to review and revise is breath-taking. Millions of documents will need to be reworked. As a barometer of the magnitude of the problem, Lehman Brothers alone was a party to more than 900,000 derivatives contracts when it went bankrupt in 2008.
She added: “And, while LIBOR is calculated for five different currencies, the value of contracts referencing US dollar LIBOR alone is estimated at $200 trillion. Banks face extensive and costly administrative work to change contracts, update computer systems, and communicate with customers to transition from LIBOR.”
The BoE and FCA said in a joint letter, published January 16: “Greater momentum is needed, and 2020 will be a key year for transition.
“Orderly and timely progress requires individual firms to actively engage with the wider transition efforts in the market – both those of the authorities and of industry. We expect to see clear evidence of this engagement from the beginning of Q1 2020.
“The RFRWG has set a series of targets for 2020, including to:
- Enable a further shift of volumes from LIBOR to SONIA in derivative markets, supported by a statement from the Bank and FCA encouraging a switch in the convention for sterling interest rate swaps from 2 March 2020;
- Cease issuance of cash products linked to sterling LIBOR by end-Q3 2020; and
- Significantly reduce the stock of LIBOR referencing contracts by Q1 2021.
They added: “The FCA and the Bank support these targets. They have also been endorsed by the Risk-Free Rate Senior Advisory Group, and are set out in the public transition road map. We expect all firms to play their part in meeting these targets.”
The two also set out a statement encouraging market makers to switch the convention for sterling swaps from LIBOR to SONIA (the Sterling Overnight Index Average benchmark) on 2 March 2020, “to help progress transition in the derivatives market.”