[co-author: Morgan Nelson]
While it seems like the COVID pandemic has taken over every waking moment of our lives, the impending end of LIBOR marches ever onward. All signs point to a termination date for the troubled benchmarks at the end of 2021, pandemic be damned.
The purpose of this post is not to discuss the road to transition so far, though if you’d like to take a trip down memory lane, here is what we have seen. Instead, we wanted to bring your attention to the fact that, whilst the UK Financial Conduct Authority’s (FCA) momentum continues, COVID has created some bumps in the road, even on the journey to the end of LIBOR.
Similar to the ARRC, the UK Working Group on Sterling Risk-Free Reference Rates (WGRFR), established back in 2015, has not only been consistent in its communications that market participants cannot rely on LIBOR being published after the end of 2021 (to which the UK regulator is fully committed), but the WGRFR has also set interim milestones to be passed on the way to achieving the enormous task at hand.
The recent tone of FCA announcements and speeches relating to LIBOR is very clear that market participants should not expect that LIBOR will be around after the end of 2021. However, COVID has derailed progress for some of the interim milestones. Following a joint statement of recognition by the FCA, the Bank of England and the WGRFR of the impact that the pandemic has had on the financial markets and thereby also on the LIBOR transition project (particularly in the sterling loan market), the WGRFR recently recommended some adjustments to the sequencing of interim deadlines. Concerned about disrupting the flow of funds to companies struggling to survive amid the COVID shutdown, the WGRFR announced that new sterling LIBOR-linked loans with a maturity date after 31 December 2021 could still be entered into until the end of March 2021. This represents a six-month extension from the date that had been originally proposed, but the extension comes with two significant conditions. Firstly, transition mechanics must be included in the loan documentation and secondly, borrowers must, in the first instance, be offered non-LIBOR-linked interest rates. Only where a borrower expressly requests a LIBOR-linked interest rate may a LIBOR-linked loan be made to it.
While the loosened timeframe should assist in providing borrowers in the sterling cash market easier access to loan capital during the COVID pandemic, the message remains that lenders, and market participants in general, should continue full steam ahead with their LIBOR transition plans and keep an eye on the long game when it comes to LIBOR.
In line with the original timeline, banks should be able to offer sterling loan products whose interest rate is not linked to LIBOR to their customers by the end of September 2020 – and only enter into LIBOR-linked loans if the borrower requests. From October 2020 clear contractual provisions must be included in any new or refinanced loan to transition to SONIA or another alternative interest rate after the end of 2021 – not just ‘fallback’ rates but express, active transition mechanics. The challenge that banks and other lenders face in doing so is undisputedly one of the greatest they have faced in decades – the legal work to agree new industry conventions and renegotiate contracts, the required upgrades to technological and operations systems, and all whilst facing an economic shutdown of unprecedented proportions.
The UK regulators did at least initially and temporarily ease some administrative burdens on them – for instance, the Prudential Regulation Authority and the FCA suspended transition data reporting at the end of first quarter of 2020 for dual-regulated banks, but full supervisory engagement will resume from 1 June 2020. Reasons for this renewed focus on LIBOR transition include those cited in the Bank of England’s Financial Policy Committee’s Interim Financial Stability Report published on 5 May 2020, which point out how the recent market volatility highlights the weaknesses of LIBOR benchmarks, and thereby also the need to move away from them.
And thus, pandemic or not, one thing appears to remain certain: LIBOR is still going away at the end of 2021.
[The authors have written this post with contributions from the London team leading Dechert’s European benchmark transition work.]
