Welcome to our July 2020 issue of the Risk Free Rates (RFR) Regulatory Round-up - LIBOR Transition.

Key regulators were out in force in July speaking on the LIBOR transition. The speeches were not to give any material new updates but rather to further emphasise to the industry the need for action now on the LIBOR transition.

In a webinar bringing together the Governor of the Bank of England and President of the New York Federal Reserve along with the Chairs of the UK RFR Working group and Chair of the ARRC, the official sector and industry bodies leading the LIBOR transition made it quite clear that they will not delay the transition because of the COVID-19 crisis or for anything else.

Key themes arising from speeches by Andrew Bailey and John Williams included:

  • Firms should stop writing new contracts referencing LIBOR.
  • Firms should resolve and transition all easier legacy contracts in the next few months, so that the focus can be on the tough legacy contracts.
  • Evidence shows that term rates are not needed for the majority of use cases and firms should not wait for these future and potential options.
  • The FCA will judge when LIBOR is no longer considered representative and will set out criteria to be used but will not set a date.
  • Firms should not wait and rely on the FCA new powers to create a replacement LIBOR methodology (“synthetic LIBOR”), as this will not provide a solution in all circumstances (especially outside the UK), and parties that rely on it will not have control over the economic terms. Regulators recommend existing LIBOR contracts are reviewed and proactively amended in advance of the end of 2021.

A day later, at an ISDA hosted webinar on 14 July, Edwin Schooling Latter of the FCA reinforced the same key messages but with a greater focus on the derivatives markets. Key points:

  • The next four to six months will be the most critical - the time to act is now.
  • ISDA and regulators have done the work, firms now need to sign up to the protocols.
  • Under EU Benchmark Regulation, supervised firms are required to have a plan for a cessation or material change in a benchmark rate - signing the ISDA protocol will meet this requirement.
  • Firms who do not sign the ISDA protocol should be ready to explain to supervisors how they will mitigate remaining risks. 
  • There could be announcements by the end of 2020 about the cessation of LIBOR settings in 2021. LIBOR may cease on certain terms on certain currencies.
  • The FCA indicated that it will only use its new powers if there has been widespread adoption of ISDA's protocols, emphasising that the 'synthetic LIBOR' is not an alternative to transition. The FCA will only use its powers to protect consumers or market integrity.

Industry panellists at the ISDA webinar emphasised that relying on fallbacks could actually be more operationally complicated than proactively transitioning to new RFRs, due to the possible limited timeframe. Panellists agreed that firms should be planning and testing for pre-cessation and cessation events. Some participants are considering other non-RFR benchmarks, e.g. Ameribor, that may include a credit-sensitive spread element. However, regulators have emphasised that market participants should be wary of transitioning to another rate that may have the same structural weaknesses as LIBOR.

Sterling market developments

The Bank of England (BoE) will publish the SONIA Compounded Index from Monday 3 August 2020. Each day's SONIA Compounded Index will be made freely available on the BoE's Interactive Statistical Database (IADB) by 10:00 on the business day after it is first published. The full series of the SONIA Compounded Index back to 23 April 2018 will be on the IADB from 3 August 2020.

In an update on resolution related rules, the PRA confirmed that if the sole purpose of a contract amendment is to transition from LIBOR, then the contract should not be considered materially amended under the Contractual Recognition of Bail-In (CROB) and Stay in Resolution (Stays) parts of the PRA Rulebook. This helps reduce the implications of LIBOR contract transition for market participants.

Euro market developments

Central counterparty clearing houses will switch from the EONIA to the €STR discounting regime on 27 July 2020. The Euro RFR Steering Group has recommended voluntary compensation for legacy swaption contracts impacted by the switch, though this is a sensitive area for market participants. It will be important for firms to address any operational challenges that arise from this switch before the SOFR discounting switch in October.

LCH and CME have provided an overview of how the discounting switch will take place on their websites.

US dollar market developments

The ARRC continues to offer practical guidance on the LIBOR transition to firms with the release of a tool (PDF 146 KB) to help firms move internal systems and processes away from LIBOR. The document lists transition activities for firms to consider, with sections on upstream and downstream areas that may be affected by the transition, and identifies dependencies that may influence the timing and sequence of transition activities.

In a further indication of regulators increasing focus on the LIBOR transition, the Federal Financial Institutions Examination Council (FFIEC), made up of representatives from all the US financial services regulators, released a joint statement on 'Managing the LIBOR transition'. It emphasises that supervisory focus on institutions' preparedness for LIBOR transition will increase in 2020 & 2021. The OCC followed with a bulletin expanding on the FFIEC statement and providing more detailed guidance for banks on supervisors' expectations.

Other markets developments

Jurisdictions outside the main LIBOR countries are now beginning to respond to the lead of the UK and US markets by setting their own LIBOR transition deadlines. The Hong Kong Monetary Authority issued (PDF 230KB) a 'Dear CEO' letter setting out its expectations for authorised firms:

  • Firms should be able to offer products referencing alternative rates from 1 January 2021.
  • From 1 January 2021 adequate fall-back provisions should be included in all newly issued LIBOR-linked contracts that will mature after 2021.
  • Firms should cease to issue new LIBOR-linked products that will mature after 2021 by 30 June 2021. 

In Japan, a draft roadmap discussed by the Cross-Industry Committee on Benchmarks sets a deadline of end-Q2 2021 for ceasing issuance of new loans and bonds referencing LIBOR.

ISDA & Bloomberg updates

On 21 July 2020, Bloomberg began calculating and publishing the fallback rates to be used to calculate the adjusted RFRs for IBOR derivative fallbacks. Bloomberg will make the adjusted RFRs, spread adjustments and all-in fallback rates broadly available to industry participants through various distribution channels, and the rates are publicly available on the Bloomberg website on a delayed basis. Firms can begin to use this data to test their system readiness for the derivative fallbacks.

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