Cash products must move away from LIBOR by September say regulators

The Financial Conduct Authority (FCA) and Prudential Regulatory Authority (PRA) have re-affirmed plans for moving UK financial services firms away from the LIBOR calculation of interest rates to ensure that LIBOR use stops by the end of 2021.

Firms will also be expected to significantly reduce holdings of contracts that reference LIBOR by March 2021, and to move derivatives contracts away from LIBOR and on to the SONIA rate.

The deadlines were set by the Working Group on Sterling Risk-Free Reference Rates (RFRWG) established by the Bank of England, and were endorsed by the UK regulators in a letter to firms (3-page / 200KB PDF).

The letter said that greater momentum was needed to ensure an orderly market transition away from LIBOR. The FCA and the PRA will continue to investigate the exercise of supervisory powers for firms that are not meeting LIBOR objectives.

The regulators have told firms that they are expected to act in 2020 to ensure a smooth transition.

"We expect all firms to play their part in meeting these targets," the letter said. "LIBOR transition plans should include the targets in project milestones and ensure that management information is available to track progress."

"As a guide, we consider that action in the following areas is key to delivery, and should feature in firms’ planning from Q1: product development; reviewing infrastructure, including updating loan system capabilities; client communications and awareness, and updating documentation," it said.

The RFRWG has established groups to investigate what is needed to move new transactions away from LIBOR; what is needed to support transition of existing cash products; and how to deal with those LIBOR products which are hard to remediate.

The RFRWG has also established the Term Rate Use Case Task Force (TR Taskforce) to identify where the use of SONIA is appropriate and to provide guidance on when a term SONIA reference rate (TSRR) might be more appropriate.

Although a sterling TSRR does not exist today, the TR Task Force said that "administrators are working on the development of an IOSCO-compliant TSRR, and it is expected that TSRRs will be published in Q1 2020 for a period of observation. The methodology for the possible TSRRs rely on a combination of overnight interest rate swaps data, tradable quotes provided by market makers and overnight interest rate swap futures data".

UK regulators have said that they expect firms should use SONIA compounded in arrears rather than TSRRs in most cases.

The TR Task Force said that use of SONIA compounded in arrears was "appropriate and is likely operationally achievable for approximately 90% by value of the sterling LIBOR loan market sampled…and that the remaining 10% by total loan value would likely require alternative rates, such as fixed rates, Bank of England base rate or a TSRR. The 10% requiring alternative rates consists primarily of lower value loans to a wide range of smaller borrowers."

The TR Task Force said: "Alternative rates should also be considered for trade and working capital products which use discounted cash flows and therefore require a forward-looking term rate with the ability to interpolate mid period dates, and Islamic finance which can pay variable rates of return so long as the variable element is pre-determined."