FCA Confirms Use of Synthetic LIBOR in Legacy Contracts

‘Synthetic’ LIBOR

ICE Benchmark Administration currently publishes 35 LIBOR settings covering sterling, US dollar, Japanese yen, Swiss franc and euro. As set out in the FCA’s 5 March announcement, publication of 24 of these settings will cease at end-2021. We expect that 5 US dollar settings (overnight, and 1-, 3-, 6- and 12-month) will continue to be published based on the current ‘panel bank’ LIBOR methodology, and on a representative basis, until end-June 2023.

Today, the FCA published notices confirming its decisions to compel the continued publication of the remaining 6 sterling and Japanese yen LIBOR settings for a limited time period after end-2021, using a ‘synthetic’ methodology. This is to help ensure an orderly wind-down.

The synthetic rate has been chosen by the FCA to provide a reasonable and fair approximation of what panel bank LIBOR might have been in the future. The synthetic rates will no longer, however, be ‘representative’ as defined in the Benchmarks Regulation (BMR).

The FCA has confirmed the methodology it will require LIBOR’s administrator to use for calculating these ‘synthetic’ rates, following its consultation proposals, as:

• forward-looking term versions of the relevant risk-free rate (ie the ICE Term SONIA Reference Rates provided by ICE Benchmark Administration for sterling, and the Tokyo Term Risk Free Rates (TORF) provided by QUICK Benchmarks Inc., adjusted to be on a 360 day count basis, for Japanese yen), plus
• the respective ISDA fixed spread adjustment (that is published for the purpose of ISDA’s IBOR Fallbacks for the 6 LIBOR settings).

These 6 LIBOR settings will become permanently unrepresentative of their underlying markets from 1 January 2022. The first non-representative publication under their ‘synthetic’ methodology will be on 4 January 2022.

A significant majority of respondents to the FCA’s consultation proposals supported this approach. The FCA will shortly publish a detailed Feedback Statement on responses received.

Use of synthetic LIBOR in legacy contracts

The FCA will decide and specify before year-end which legacy contracts are permitted to use these synthetic LIBOR rates. The FCA has published a consultation on its proposed decision today. 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. Clearing houses plan to transition all cleared sterling, Japanese yen, Swiss franc and euro LIBOR contracts to risk-free rates by end-2021.

The FCA encourages firms to respond to its consultation by 20 October. The FCA will confirm its final decision on permitted legacy use as soon as practicable after the consultation closes.

Market participants have made good progress in actively transitioning contracts in line with the Working Group on Sterling Risk-Free Reference Rates’ recommended end-Q3 target. But the proposals today recognise that it will not be practicable to convert all outstanding sterling and Japanese yen LIBOR contracts by year-end. The FCA and PRA will continue to monitor firms’ efforts to remove any remaining dependencies on LIBOR across all asset classes, both leading up to and after end-2021.

Users of LIBOR should continue to focus on active transition rather than relying on synthetic LIBOR. Synthetic LIBOR will not be published indefinitely. The FCA must review the use of its power to require publication of a ceasing benchmark at least annually (up to a maximum period of 10 years). For the 3 Japanese yen settings, the FCA does not intend to renew the requirement, and publication will therefore cease at end-2022. The FCA will also consider progressively restricting continued permission to use synthetic LIBOR in legacy contracts if this would help maintain progress towards an orderly cessation, and thereby support its objectives to protect consumers or market integrity. This may be necessary if, for example, work to reduce the stock of outstanding legacy LIBOR contracts does not continue.

US dollar transition

The FCA also continues to monitor progress in US dollar LIBOR transition.

The consultation published today sets out the FCA’s proposed decision to prohibit most new use of US dollar LIBOR after end-2021, in line with US guidance and existing FCA and PRA supervisory expectations.

The decisions to require publication of some sterling and Japanese yen LIBOR settings on a synthetic basis are not determinative of any future decisions in respect of US dollar LIBOR from end-June 2023.

Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, commented: ‘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.’

Source: FCA