How tough is Tough Legacy? FCA announcement on synthetic LIBOR

On 29 September the FCA (Financial Conduct Authority) announced that they will require benchmark administrators to publish a ‘synthetic LIBOR (London Interbank Offered Rate) rate’ post cessation during 2022 for Sterling & Yen, and they are launching a consultation on permitted uses of these synthetic rates.

Below is just our first take given what has been said so far.

Did we see this coming?

The fact that there would be a synthetic rate for Sterling LIBOR based on Term SONIA (Sterling Overnight Interbank Average Rate) plus a fixed credit adjustment spread published by ICE (Intercontinental Exchange, Inc) is no surprise. Industry was expecting an announcement before the end of Q3, so that is no great reveal. 

And just to blow our own trumpet, we did predict this back in October 2019 with “LIBOR on the ropes but when is the knockout blow?”, scroll down to ‘What to do with tough legacy’ to look at our crystal ball.

What is more interesting is the consultation around the permitted use(s) of the synthetic rate. Back in the day (May 2020) the £RFR Working Group (Working Group on Sterling Risk-Free Reference Rates) produced a paper on Tough Legacy setting out some expectations, but fair to say mood music from official sector has until now been muted. General line has been “don’t rely on tough legacy to solve your problems, get fallbacks and active transition in place asap”.

And in fairness this has been a sound approach that has kept focus on transition until now, and certainly in the derivatives space has resulted in the vast majority of positions now having robust fallbacks. But we sense a change in tone now - there is still the statement in the press release “Users of LIBOR should continue to focus on active transition rather than relying on synthetic LIBOR” but that said, there is a clear acknowledgement that to avoid market disruption the authorities will permit a wide range of legacy LIBOR contracts in GBP & JPY to reference the synthetic rates post-cessation:

“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.”

That last bit is interesting... it looks like loans (bilateral & syndicated), bonds, securitisations and remaining bilateral derivatives that have no fallbacks will all be eligible to reference the synthetic LIBOR rate, at least in the immediate future following 1 January 2022. 

The notice the FCA sent to ICE on 10 September is instructive in understanding the reasons behind the decision to compel them to publish the synthetic rate, and the likely outcome of the consultation. They anticipate a ‘material proportion’ of the current Sterling LIBOR exposure of £472bn will remain outstanding at year end (even following fallbacks and planned transition activities). Without a tough legacy solution “widespread market disruption and a disorderly cessation would likely be caused”.

So, we can relax, Christmas isn’t cancelled?

Well, there is more breathing space to re-negotiate those final LIBOR contracts (assuming the consultation goes through as proposed) but the authorities are very much pressing market participants to get on and finish the job. They are only promising a published legacy rate through 2022 (JPY confirmed as only 2022, GBP to be reviewed annually), and reserve the right to tighten restrictions on who may and may not use that rate on legacy contracts through the year.

And on relaxing in the run up to Christmas, anyone involved in the transition activities for Clearing Houses, or the implementation of fallbacks will still have plenty on their plate other than turkey.

And what about USD?

The other thing announced today was a re-iteration of the controls around no new USD LIBOR from 1 January 2022 onwards (except for risk management purposes in the case of derivatives). This isn’t a surprise, and links through to the statement by the Fed back in November last year. Only thing of note is that unlike the milestone controls for GBP LIBOR this year, for USD LIBOR they are not even allowing new transactions that mature before June 2023 to be executed after January 2022, unless they meet the hedge exception criteria.

So subject to confirmation of the outcome of the consultation in October (and we can’t imagine many in the industry will challenge the FCA’s general direction of travel here), there will be a little more wriggle room for those last contracts that have not got over the line yet. But not too much. 

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