GovernanceInterest RatesFirms need to do more to prepare for Libor transition

Firms need to do more to prepare for Libor transition

Despite warning, BOE's Ramsden says progress is being made in the migration to Sonia.

Organisations need to do more to prepare for the switch from the discredited Libor interest rate benchmark to a Bank of England alternative by the end of 2021, according to Dave Ramsden, the Deputy Governor for Markets & Banking at the Bank of England (BoE).

The warning comes despite market participants claiming that the migration to the BoE’s Sterling Overnight Interbank Average Rate (SONIA) overnight interest rate is too huge a task to meet the deadline.

Speaking at the BoE’s Last Orders: Calling Time on Libor event, Ramsden said: “Firms need to be focused on what they need to do in order to transact Sonia-based products, and stop adding to their post 2021 Libor exposures.”

Authorities, internationally, have been calling time on Libor for a while. Panel banks have agreed to continue to submit to Libor until the end of 2021, securing its future until then, but not beyond. “This is a global issue – affecting multiple currencies,” continued Ramsden. “The need to transition is a critical one for all involved.”

Last orders

While calling time on Libor, Ramsden did share some positive news about the transition from Libor to its successor.

“There has been real progress in establishing SONIA as the successor to sterling Libor. In the past six months there have been a number of positive developments in the sterling cash market.

“From a zero base this time last year, SONIA linked floating rate note (‘FRN’) issuance now dominates sterling floating rate financials issuance and there is clear momentum towards using the compounded SONIA rate across bond markets. The first five months of 2019, have seen 21 different banks, sovereigns, and supranationals issue FRNs referencing compounded SONIA, with a total value of about £19bn.”

Ramsden continued: “We’ve also now seen the first move by a bond issuer to switch their outstanding Libor linked bond to reference compounded SONIA instead. They are currently going through a bondholder Consent Solicitation process, with the deadline next week. This is a development which is being closely watched.

“We have also seen the first SONIA linked securitisations issued. In other areas, we are seeing progress. One UK firm has announced it has switched the basis of its balance sheet over to SONIA. And in OTC derivatives, the notional value of cleared SONIA swaps is now only slightly less then cleared Libor referencing swaps, with SONIA starting to dominate at shorter maturities; but this hasn’t materially changed over the last six months. SONIA futures as a share of the overall market have increased, but stand at only a small portion of the total.

“However, we are yet to see a SONIA based loan. There is also a need for further progress in building required infrastructure, not just to issue, but to hold, value, and risk manage SONIA based instruments. This progress is a positive sign, but the pace of progress needs to accelerate. There is much more to be done.”

LIBOR: Tough legacy

Market participants have said switching to SONIA overnight interest rate is too huge a task to meet the deadline.

The SONIA is compiled by the BoE and based on actual transactions and seen as harder to manipulate than LIBOR, which is based on quotes supplied by banks.

FCA Chief Executive Andrew Bailey said at a BoE event: “The deadline was ambitious and aggressive, but necessary given that LIBOR remains fundamentally fragile and it should not be allowed to limp on year after year.

“I think we are at least up to and if not probably somewhat ahead of where I’d hoped we would be on that front by now. We do realise the issue out there. We’ll have to have the discussion on this tough legacy.”

LIBOR is to be found not only deeply embedded across firms’ assets and liability structures, but also in a wide range of applications and infrastructure used for valuation, pricing, performance evaluation and risk management.

“Dear CEO”

In September 2018, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) send a “Dear CEO” letter to CEOs of major banks and insurers supervised in the UK asking for details of the preparations and actions they are taking to manage transition from LIBOR to alternative interest rate benchmarks.

The purpose of these letters was to seek assurance that firms’ senior managers and relevant governance committee(s) understand the risks associated with this transition and are taking appropriate action now so that firms have transitioned to alternative rates by the end of 2021.

These letters were sent directly to the largest banks and insurers.

The regulators have reviewed responses from those firms that were direct recipients of the original letter and provided those firms with feedback. Today, the FCA and the PRA published a set of observations from their work to date.

SONIA: Progress so far

Many of the responses showed that firms had started proactively to transact alternative RFRs (risk-free rates) to some extent. This supported progress in reducing exposure to LIBOR and added credibility to forward plans to reduce exposure. A significant number of responses, however, did not provide sufficient detail on plans to support transacting alternatives e.g. plans to update and test systems to execute, price and value new RFRs and the relevant governance process for new products.

A number of firms’ responses placed considerable reliance on the development of ‘market’ solutions to overcome potential barriers to transition e.g. relying on the development of a forward- looking term rate, waiting for market liquidity to build up in new RFR products.

Where firms are not yet ready to transact RFRs, most indicated they have begun updating fallback language in new LIBOR issuances. Compliance and Legal functions were key members of project teams behind stronger responses. These same firms also showed active understanding of the work of various market participant groups and trade associations regarding fallbacks.

BoE has also seen the first move by a bond issuer to switch their outstanding LIBOR linked bond to reference compounded SONIA instead. They are currently going through a bondholder Consent Solicitation process, with the deadline next week.

Further, the first SONIA linked securitisations have been issued.

And in OTC derivatives, the notional value of cleared SONIA swaps is now only slightly less then cleared LIBOR referencing swaps, with SONIA starting to dominate at shorter maturities; but this has not markedly changed over the last six months. SONIA futures as a share of the overall market have increased, but stand at only a small portion of the total.

Similar migrations are underway in the euro zone, United States and Switzerland.

Before preparing for moving away from LIBOR, one of the most labour-intensive considerations treasurers must bear in mind will be necessary changes to fallback provisions across a range of documentation.

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