FCA introduces synthetic rates as reality hits

The Financial Conduct Authority (FCA) has announced that several LIBOR panels, which will cease to exist by year-end, will have to publish rates to ensure an “orderly wind-down” as the industry transitions away from LIBOR benchmarks.

The decision taken, which will affect six remaining sterling and Japanese yen LIBOR settings for “a limited time period” after the end of 2021, was taken to avoid the disruption of legacy contracts.

The FCA first warned market participants to prepare for the cessation of LIBOR in 2017, leading the organisation to encourage fund managers to seek alternative benchmarks.

With 24 LIBOR settings set to wind down by the end of the year, however – including sterling, yen, euro and Swiss franc panels – the FCA said it is “not practicable to convert all outstanding sterling and Japanese yen LIBOR contracts” over the next three months.

Edwin Schooling Latter, director of markets and wholesale policy at the FCA

As a result, LIBOR benchmark administrators for one-, three- and six-month sterling and Japanese yen settings will publish a synthetic methodology based on term risk-free rates for the duration of 2022. These will only be available for use in “some legacy contracts”, according to the FCA,

The watchdog said, they are not for use in new business. From 1 January 2022, they will become Article 23A benchmarks under the Benchmarks Regulation (BMR), which grants the FCA the ability to designate a critical benchmark in certain circumstances to entities that need it.

Edwin Schooling Latter, director of markets and wholesale policy at the FCA, said: “Market participants have made huge progress in moving away from LIBOR. Today’s publications confirm some important details of how LIBOR will now be brought to an end.

“New use of sterling, Japanese yen, Swiss franc, euro, and – with only limited exceptions, US dollar – LIBOR will have to stop at end-2021. The publication of a synthetic rate for some sterling and Japanese yen LIBOR settings for a limited period will give market participants a bit more time to complete transition of legacy contracts. We encourage firms to use that time well.”

Ovie Koloko, Global Head of Product Development at Parameta Solutions, notes that despite the announcement of the new replacement rates, “the switch creates both operational challenges and opportunities for end users as there are now multiple rates being used for different products.

He adds, “For many market participants, the variety in rates means that they will be using the most relevant rate, but for others, such as SMEs, the landscape will be less clear as they have to navigate both SONIA and Synthetic Libor. Through this move, the FCA is encouraging most historic users to move to SONIA (Sterling Overnight Index Average) but supporting those who face operational and data challenges in doing so.”

Charlie Browne, Head of Market Data & Risk Solutions, GoldenSource also believes that the “idea behind this ‘legacy use’ proposal by the FCA is to permit the continued use of existing Libor-based approaches. Clearly, more time is needed for organisations that have Libor-referencing contracts to understand and calculate the methodologies behind the new risk-free-rate (RFR) approaches – and communicate the impact to their customers.

He says, “Certain groups of RFR users (including banks, building societies, investment managers, life insurance/pension providers and mortgage lenders) who refer to LIBOR in financial or other contracts are not ready to fully transition. These organisations require more time to move away from the existing LIBOR rates in many of the contracts they have with their customers that reference LIBOR. Obtaining permission from bondholders or borrowers is a time-consuming process and will not be achievable by the end of 2021 in many cases.”

©Markets Media Europe 2021

 

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