The FCA published a consultation paper and associated press release on 29 September dealing with its further arrangements for the wind-down of LIBOR at the end of 2021.
Investment firms have been aware for some time (and with certainty since the FCA’s announcement on 5 March 2021) that sterling LIBOR settings (along with others, including Japanese yen, Swiss franc and euro) will cease to be representative from 31 December 2021.
The FCA has now announced that to avoid disruption to legacy contracts that reference the 1, 3 and 6 month sterling and Japanese yen LIBOR settings, it will require the LIBOR benchmark administrator (ICE Benchmark Administration) to publish these under a “synthetic” methodology for the duration of 2022. These will only be available for use in certain legacy contracts, and must not be used for new business.
The FCA’s 29 September 2021 consultation paper (CP21/29) considers which legacy contracts will be able to use synthetic LIBOR next year. The proposal is to permit legacy use of synthetic sterling and yen LIBOR in all existing contracts except those for cleared derivatives (due to rule-changes implemented by clearing houses meaning that this is not necessary).
The goal is to ensure an orderly wind-down of these LIBOR settings throughout the course of next year. The FCA has been encouraging firms to actively introduce replacement rates into their existing contracts. However, for many existing contracts referencing LIBOR, for example regulated mortgage contracts, express customer consent may be necessary in order to make the change. It may be difficult in each and every case to get borrowers to respond, meaning that technically it is not possible to amend the agreement. Further, such contracts are less likely to contain suitable and effectively drafted fallback language. It is worth noting that fallback language may not work effectively while synthetic LIBOR settings remain in effect, since such language may operate only when the relevant LIBOR setting ceases permanently. This will however, depend on the precise wording of individual contracts.
The FCA states that: “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'”.
The FCA has confirmed the methodology to be used for calculating the synthetic rates, which is a forward-looking version of the relevant rate (for example, the ICE Term SONIA Reference Rates for sterling) plus a ISDA fixed spread adjustment. This matches up with the methodology that many investment firms are using as the calculation for the replacement rates for their legacy contracts, going forward.
The FCA acknowledges that market participants have made good progress in transtioning contracts but that it will not be practicable to convert all contracts for sterling and yen LIBOR by year end. They state that firms should continue to focus on active transition (amending contracts where practicable and on a best efforts basis), since this is the best way to avoid uncertainty, and that they should not rely on synthetic LIBOR.
"Today, the FCA is confirming that to avoid disruption to legacy contracts that reference the 1-, 3- and 6-month sterling and Japanese yen LIBOR settings, it will require the LIBOR benchmark administrator to publish these settings under a 'synthetic' methodology, based on term risk-free rates, for the duration of 2022."