Bank of England Targets Libor Transition For Loans

The Bank of England is setting up a loans enabler task force as awareness of the transition from Libor remains low outside of large corporations.

Tushar Morzaria, Barclays

The UK central bank published the November minutes of the Working Group on Sterling Risk-Free Reference Rates, led by Barclays’ Tushar Morzaria, on its website last month. The working group is made up of experts from large sterling swap dealers and discusses the development of sterling risk-free reference rates.

After the financial crisis there were a series of scandals regarding banks manipulating their submissions for setting benchmarks across asset classes, which led to a lack of confidence and threatened participation in the related markets. As a result, regulators have increased their supervision of benchmarks and want to move to risk-free reference rates based on transactions, so they are harder to manipulate and more representative of the market. The UK has chosen the sterling overnight index average, Sonia, as its new risk-free rate. The UK Financial Conduct Authority said two years ago that it will not compel panel banks to submit to Libor beyond 2021.

The working group minutes said there was a presentation on initial findings on appropriate use cases for term rates in sterling markets

“This estimates that 90% of Libor lending in sterling by value could be moved to compounded in arrears,” added the minutes.

This share covers all lending to mid-to-large corporates and public-sector institutions while the remaining 10% by value, consisting of smaller corporates and retail clients, could use a range of other options.

“These included Bank Rate, a fixed rate or a Sonia term rate,” said the minutes. “A term rate was also thought to be a cost-efficient solution for legacy Libor loans with a term that extends shortly past end 2021.”

A loans enabler task force is being set up to bring together communications, infrastructure and documentation expertise in order support the working group’s target of ending new issuance of sterling Libor-linked cash products by the third quarter of this year 2020.

“It was noted that awareness of Libor transition remained low outside of large corporations,” added the minutes. “Significant effort would be needed to educate these users due to the large numbers of smaller borrowers.”

Some progress has been made in the loan markets with the first conversion of a loan from Libor to Sonia between NatWest and South West Water.

In the bond market, Associated British Ports successfully converted  a floating rate bond from Libor to Sonia in June via consent solicitation and the FCA has supported market participants in identifying candidates for further conversions.

“The results have been encouraging, with over £4bn ($5.2bn)of sterling securities now converted to Sonia,” said the minutes.  “Lessons learned in this process will be shared with the bond market sub-group and included in the working group’s planned paper on legacy sterling cash products.”

The Bank of England and the FCA have also jointly sent letters to large liquidity providers to confirm commitments to streaming executable prices in overnight indexed swap markets.

“From February 2020, market making firms had committed to stream executable quotes for 1, 3 and 6 month Sonia OIS, supporting the beginning of a testing period for forward-looking term rates using these quotes,” added the minutes. “The timing for live production of these rates would be kept under review and was initially expected to commence around the third quarter of 2020. The potential administrators and the platforms had been informed of these developments and the letter would be made available publicly.”

FSB progress report

The Financial Stability Board has also highlighted that good progress on the transition from Libor has been made in many derivatives and securities markets, but progress in lending markets has been slower, and needs to accelerate.

The FSB last month published its annual progress report on the move to new risk-free reference rates and said the continued reliance on Libor poses risks to financial stability.

The report called for significant and sustained efforts by the official sector and by financial and non-financial firms across the globe to transition away from Libor by the end of next year. The FSB continued that given the degree of risk arising from the continued reliance on Libor, regulated firms should expect increasing scrutiny of their transition efforts as the end of 2021 approaches.

Andrew Bailey, FCA

Andrew Bailey, FSB

Andrew Bailey and John Williams, co-chairs of the FSB Official Sector Steering Group, said in a statement: “It is essential that both firms and national authorities around the world take steps now to ensure a smooth transition. As a matter of priority, authorities should discuss with financial institutions, and financial institutions with their clients, the transition process and agree on the steps needed.”

The FSB announced last month that it will conduct a survey of exposures to Libor and supervisory measures being taken to address benchmark transition issues as part of its 2020 work programme. The regulator will then deliver a report to G20 finance ministers and central bank governors in July this year.

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