UK Reviews Market Infrastructure For Libor Transition

Shanny Basar

A Bank of England committee is setting up a working group to engage with technology and infrastructure providers to ensure that the industry will be operationally ready for the transition to new reference interest rates.

The UK central bank chaired a meeting of the Working Group on Sterling Risk-Free Reference Rates on 20 August and published minutes on its website today. The minutes said the chair introduced a representative from fund manager M&G who will be one of the co-chairs of the newly established market infrastructure sub-group alongside NatWest Markets, the UK investment bank.

“He encouraged members to notify the Secretariat of any expressions of interest in participating in the sub-group,” added the report. “He explained that the sub-group would establish a list of infrastructure and operational readiness issues, and seek to engage with technology and infrastructure firms via panels and roundtables to identify solutions to those issues.”

There have been a series of scandals regarding investment banks manipulating the Libor interest rate for their own benefit, which resulted in regulatory penalties of around $10bn (€8.5bn). As a result, the index is being retired in 2021 and replaced by Sonia – the sterling overnight index average – which is based on actual transactions. The Bank of England took over as Sonia administrator and began producing the rate in April this year.

Need to prepare

The Financial Policy Committee of the Bank of England has warned that continued reliance on Libor poses a risk to financial stability that can only be reduced through a transition to alternative rates.

Richard Hopkin, head of fixed income at the Association for Financial Markets in Europe, wrote that the industry needs to urgently begin planning for the transition to the new risk-free reference rates.

“Interbank offered rates or ‘IBORs’ – of which Libor is the most well-known – are used as reference rates for financial contracts such as bonds, securitisations and derivatives worth in the order of €100 trillion globally,” said Hopkin.

AFME and other industry bodies recently published The IBOR Global Benchmark Transition Report which surveyed 150 capital markets participants and concluded that many firms, issuers and investors have not begun serious preparations.

Lacking a clear sense of direction

“It found that while 87% of market participants are concerned about their exposure to IBORs and are familiar with the matter, only 11% have allocated budget to resolving the issue and just 12% have developed a preliminary project plan,” Hopkin added. “The survey also found that part of the reticence for taking action comes from industry lacking ‘a clear sense of direction’ from regulators and working groups about both the desired end state as well as how firms should approach key issues such as tackling legacy transactions, which are linked to an IBOR.”

The Bank of England committee agreed that the next meeting in September will consider fallbacks for syndicated loans which use Sonia as a reference rate, as well as draft conventions for referencing Sonia compounded over the interest period in loan agreements.

In the bond markets the next meeting will also discuss the conversion of legacy Libor-linked bonds to Sonia, and will work on a set of preferred conventions for adoption of Sonia compounded over the interest period in bonds.

“The sub-group will be considering the differences between the Sonia-referencing European Investment Bank bond and the SOFR-referencing Fannie Mae and World Bank bonds,” added the minutes.

The European Investment Bank printed the market’s first Sonia benchmark with a £1bn ($1.3bn) five-year bond in June this year. In the US, the largest derivatives market in the world will transition to the Secured Overnight Financing Rate, which differs from Sonia. For example, SOFR is secured while Sonia is unsecured.

The Bank of England’s next meeting will also include a presentation on the consultation on the transition to new reference rates from ISDA, the derivatives market trade association.

“It is welcome that ISDA has released its consultation on technical issues related to the introduction of fallback arrangements for derivatives contracts, which reference certain IBORs,” added Hopkin. “But while it goes without saying that until many more details are finalised it won’t be possible for firms to put concrete arrangements in place, waiting for every ‘i’ to be dotted before taking action isn’t really an option.”

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