Despite pandemic, ‘time to act is now’ on LIBOR transition

And yet, the expiration deadline for the London Interbank Offered Rate (LIBOR) continues to move closer, uninterrupted. Unlike the examples listed above, LIBOR is globally utilized, so the particular struggles of any one country aren’t likely to throw its long-planned demise off course.

“While we know LIBOR will continue to be published until end-2021, this does not mean the need to act is still more than a year away,” said Edwin Schooling Latter, director of markets and wholesale policy at the U.K. Financial Conduct Authority (FCA), in a Webinar speech delivered July 14 and published this week. “Nor has the need to act on LIBOR transition been pushed back by the impact of coronavirus. In fact, the four to six months ahead of us are arguably the most critical period in the transition away from LIBOR. The time to act is now.”

It may seem impractical to focus on a change set for the end of 2021 when our day-to-day lives have been thrust into unpredictability by the ongoing pandemic, but Latter isn’t the first to stress the importance of acting on LIBOR transition. The U.S. Securities and Exchange Commission in July 2019 discussed the need for “urgency” on the matter in an effort to avoid business and market disruptions when the expiration date comes. The Federal Reserve and Commodity Futures Trading Commission last year also sought to provide assistance while boosting the Fed-backed Secured Overnight Financing Rate (SOFR) as the preferred alternative.

In alignment with the timing and tone of Latter’s comments, each of the aforementioned regulators has taken an action in recent weeks to put LIBOR back in the spotlight. The SEC’s Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert  on June 18 regarding transition preparedness, the CFTC’s Market Risk Advisory Committee on July 21 approved recommendations for a scheduled October 2020 transition of certain products to SOFR, and New York Fed President John Williams boasted last month about how SOFR has fared amid the market stresses caused by the coronavirus.

“If the pandemic has confirmed one thing about financial benchmarks, it’s the resilience of robust reference rates,” remarked Williams.

All this is to say LIBOR transition moves on while the rest of the world is seemingly stuck in neutral. Latter, whose words carry added weight as a representative of the regulator that oversees the maintenance of LIBOR, focused the start of his speech on an impending protocol set to be finalized later this month by the New York-based International Swaps and Derivatives Association (ISDA) that will help LIBOR contracts transform to work with new reference rates. The protocol will carry a four-month adherence period upon publication.

“I think it is accepted across the board that the current arrangements in older uncleared derivatives contracts for the end of LIBOR just aren’t fit for purpose anymore,” Latter said. “… You could be left with a contract that no longer works. Not signing the protocol therefore seems a huge risk to take.”

Latter continued by discussing the potential creation of a “synthetic” LIBOR, which the FCA is expected to receive the power to utilize. A synthetic LIBOR would be designed to provide a way of resolving issues around legacy LIBOR contracts that cannot practicably be converted. “These powers are not an alternative to transition,” Latter said. “Firms still need to be ready for life without LIBOR.” A synthetic LIBOR would not be viewed as a suitable foundation for derivatives markets and instead would just be used to bridge the gap in transition.

Latter ended his speech stressing the need for the conversion of LIBOR legacy books to already be underway. “In our supervisory capacity, FCA will be expecting firms to be able to show not only that they have robust fallback documentation in place before LIBOR ceases or becomes unrepresentative, but also that they have completed transition for all new business and have plans that make use of opportunities to reduce legacy LIBOR books before the end comes,” he said.

It isn’t just the FCA with its eyes on transition efforts—the OCIE identified registrant preparedness for the transition away from LIBOR as an examination program priority for fiscal year 2020 in its Risk Alert. Firms not making an effort to address the transition’s impact on business activities; operations; services; and customers, clients, and/or investors have been warned: “The time to act is now.”