In light of the coronavirus pandemic, you might be forgiven for forgetting that there are fewer than 18 months until the expected cessation of LIBOR (London interbank offered rate) and the anticipated transition by many UK lenders and borrowers to the new “risk-free rate” SONIA (sterling overnight index average), as set out in our briefing note published in May this year.
We summarise below some key LIBOR transition developments that have occurred since then.
General WG update
The Working Group on Sterling Risk-Free Reference Rates (WG) published a statement last month promoting the publication of a suite of materials designed to help market participants implement their LIBOR transition plans. The materials include:
- WG’s updated top-level priorities for 2020-2021
- An updated retrospective and forward-looking roadmap, which emphasises the need for firms to actively promote transition, sets new targets for the transition of LIBOR products and gives a detailed breakdown of the milestones required to help manage the transition away from sterling LIBOR products by the end of 2021 and
- A useful Q&A document which provides additional clarity on WG’s end of Q3 2020 milestones as well as targeted information regarding the effects of the transition across loan products
In addition, the WG recommended that from the end of Q3 2020, all lenders should be providing their borrowers with clear contractual arrangements in all new and refinanced LIBOR loan documentation to facilitate the transition to SONIA or other alternative rates before the end of 2021.
Refinitiv release prototype forward-looking SONIA reference rate
As mentioned in our May 2020 briefing note, SONIA is backward-looking – it cannot be determined until the end of an agreed interest period. LIBOR is forward-looking – it is agreed at the start of an interest period. Many market participants believe that a forward-looking SONIA term rate set at the beginning of the relevant period is essential to provide borrowers with visibility and financial certainty on their interest payments.
On 21 July 2020 fintech company Refinitiv announced the launch of a prototype forward-looking term SONIA reference rate published daily prior to noon (UK time) and available in one-month, three-month and six-month tenors. The Refinitiv prototype is an addition to beta forward-looking term rates published by FTSE Russell and ICE Benchmark Administration.
It will be interesting to see how Refinitiv’s prototype is used by market participants, with firms already able to evaluate its behaviour and suitability and test its technical/operational integration. The prototype is accessible free of charge on Refinitiv Workspace, Eikon and DataScope platforms as well as via the Refinitiv website. Refinitiv expect to launch a regulated version of the rate towards the end of 2020, to coincide with many lenders’ anticipated offering of non-LIBOR linked products to their customers.
UK legislation for “synthetic” LIBOR
It was announced in June 2020 that the UK government intends to pass legislation to grant the FCA enhanced powers to require the administrator of LIBOR to change its methodology to calculate a “synthetic” LIBOR if the FCA deems it necessary to protect consumers and the market. This would enable the continued publication of LIBOR, creating additional options to manage the transition to other risk-free rates before LIBOR ceases (by the end of 2021).
This announcement was largely a response to a call to action by the WG following their review of the “tough legacy” issues in a LIBOR transition. By “tough legacy” we mean areas of the financial market and/or financial products where a consensual transition away from LIBOR to a new risk-free reference rate would be particularly difficult, e.g. contracts which are not suitable for transition to other risk-free rates, usually because the required rates are not yet available or where the investor base is highly diverse (making obtaining consent for contractual changes impractical). The proposed solution is to implement a synthetic methodology which would allow for tough legacy contracts to continue to reference LIBOR until their scheduled maturity, avoiding potentially widespread market disruption which could result from a sudden cessation.
For those readers looking for an even more comprehensive explanation of the LIBOR transition including recent developments, as well as the reasoning for the transition in the first place, the Bank of England (together with the WG) has released a series of educational videos (links to the first two videos are available here and here).
Andrew Dodds, banking and finance partner at Stevens & Bolton LLP comments:
"Lenders, borrowers and other market participants need to continue to actively participate in LIBOR transition. They must work together in order to agree suitable processes to convert existing and new LIBOR loan products to SONIA (or other suitable alternative rates), so as not to be caught out in 2021."