FCA : Preparing For The End Of Libor
Speech by Andrew Bailey, Chief Executive of the FCA, at the Securities Industry and Financial Markets Association’s (SIFMA) LIBOR Transition Briefing in New York, USA
- Transition from LIBOR has made good progress across derivatives and securities markets, and transition in loan markets is a key next step.
- Andrew Bailey sets out the benefits to borrowers of the move to risk-free interest rate benchmarks – UK lenders will need to begin engaging with borrowers about lending based on these rates.
- We expect the LIBOR panels to dwindle or disappear after end-2021 – firms must be able to run their business without LIBOR from this date, and reduce the stock of ‘legacy’ LIBOR contracts.
I am grateful for this opportunity to update markets on the next important phase of transition away from London Inter-bank Offered Rate (LIBOR) to Secured Overnight Financing Rate (SOFR), Sterling Overnight Index Average (SONIA) and the other chosen risk-free rates.
1. Update on progress
The transition is happening.
Markets in the risk-free alternatives to LIBOR continue to develop.
Open interest in SOFR futures has grown to close to half a trillion dollars. In SONIA futures, open interest, which was close to zero in April 2018, had climbed steadily to £129 billion by end June.
The numbers of SOFR-referencing swap transactions are still small, but growth is clear, and continuing. Although – at the moment – LIBOR still dominates swaps markets in the United States, the growth in SONIA swaps in the UK is illustrative of how change can happen. The notional of outstanding cleared SONIA swaps now exceeds £10 trillion.
In the first 6 months of this year, SONIA accounted for a little over 45% of notional swaps trading in sterling. Importantly, the growth in SONIA volumes is particularly notable at longer maturities. Since first half (H1) 2017, there has been 380% growth in (duration-adjusted) traded notional at maturities over 2 years, compared with 150% for swaps of less than 2 years.
In cash markets, SONIA is now the market norm for new issuance of sterling floating rate notes. Since the first new SONIA-referencing issue in a decade – just over a year ago in June 2018 – we have now had £28 billion of new issuance referencing SONIA. We have not had a new unsecured listed public bond referencing sterling LIBOR and fixing past end-2021 since October last year. Issuance of US dollar bonds referencing SOFR, is even more substantial, having reached US$135 billion by end-June.
In the first half of this year, we also saw a dramatic change in securitisation markets in the UK. The first ever securitisation referencing SONIA was completed in December 2018. In quarter 2 (Q2) this year, two thirds of new public deals referenced SONIA.
Transition is not just about new business but about converting outstanding – or legacy – LIBOR contracts.
This is harder in some markets than in others.
In derivatives markets, there is a variety of ways to do so. The most forward-looking UK players have already closed out their LIBOR-referencing contracts in favour of SONIA.
The conversion challenge is perhaps hardest of all in bond markets, where consent solicitations are required. But last month one UK issuer, Associated British Ports (ABP), proved it can be done. Both issuers and investors can benefit from conversion. The successful ABP consent solicitation sets a useful precedent and model that others can follow.
Transition will need to occur not only in derivative, debt and loan market contracts, but also in systems and policies that reference LIBOR. We saw one notable example of transition in Switzerland in June. The Swiss National Bank (SNB) announced(link is external) that a new SNB policy rate will replace the target range for 3-month Swiss franc LIBOR in its monetary policy strategy. The SNB will seek to keep the secured short-term Swiss franc money market rate close to the new policy rate. It has been clear that Swiss Average Rate Overnight (SARON) – the Swiss market’s chosen risk-free rate – is the most representative short-term money market rate available.
And at the beginning of this month, Japan’s Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks also released its public consultation(link is external)on key transition steps for Japanese market participants needing to prepare for the discontinuation of LIBOR at end-2021.
Transition away from LIBOR in loan markets is a key step ahead
The market in which transition is least advanced is loans. LIBOR-referencing loans are common in lending to non-financial corporations and similar borrowers. Here there is a major transition programme to be undertaken, and on which progress is needed in the year or so ahead.
The green shoots of change are there. On 1 July, the Financial Times reported a first overnight SONIA-referencing revolving credit facility to a UK non-financial corporation, National Express. We know that other non-financial corporates have – for good reasons, which I will return to – been asking for new lending based on SONIA rather than LIBOR. Other Requests for Proposals (RFPs) have been issued. We know that a growing number of banks are now able to lend using SONIA – at least on a bilateral basis. We understand banks are now exploring putting syndicates together too.
The Loan Market Association in Europe, and its equivalent in the US (the Loan Syndications and Trading Association (LSTA)) are making progress on essential work to develop new standardised documentation for syndicated loans referencing overnight RFRs rather than the forward-looking LIBOR term rates that have been used to date.
Delivery of that documentation – and its use – will be key next steps in the transition.
One potential advantage of several different markets in several different jurisdictions working on transition in parallel has been the opportunity to increase alignment of conventions. We have seen, for example, use of the daily compounding already standard in derivative markets now used also in bonds on both sides of the Atlantic. We have also seen compounding being built into new SONIA-linked loan products. Seizing these opportunities to align helps to remove basis risk between different contractual obligations, and increase the efficiency of hedges.
Alerts estimate the likelihood that a corporate security will undergo a significant change in credit spreads.
The partnership with LiquidityEdge will add Treasury net hedging capabilities for corporate bond trades.
The bond market steadily warms to the new technology.
ETF inflows were as plentiful as the summer sun in June.
Least progress has been made in the loans market.