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FCA: UK must begin 'transition' away from reliance on LIBOR benchmark

Out-Law News | 31 Jul 2017 | 11:22 am | 2 min. read

The UK's financial markets must begin work "in earnest" to transition away from the use of the London Interbank Offered Rate (LIBOR) as a benchmark interest rate for use in financial transactions, the head of the financial regulator has said.

Speaking in London, Financial Conduct Authority (FCA) chief executive Andrew Bailey said that the panel banks whose submissions currently inform the LIBOR rate had voluntarily agreed to continue to support it until the end of 2021. This would "enable a transition that can be planned and can be executed smoothly", he said.

"This date is far enough away significantly to reduce the risks and costs of a more sudden change," he said. "By having a date by which transition will need to be complete, however, we give market participants a schedule to plan to, and make it easier for them to engage as many counterparties and LIBOR users as is practically possible in that planning."

"Our intention is that, at the end of this period, it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR. It would therefore no longer be necessary for us to sustain the benchmark through our influence or legal powers," he said.

LIBOR is a daily reference rate based on the interest rates at which banks can borrow unsecured funds from other banks, and is used to underpin the pricing of more than $350 trillion worth of financial instruments around the world. It is one of eight benchmark rates regulated by the FCA. LIBOR has been administered by ICE Benchmark Administration (IBA) since February 2014, when it took over the role from the British Banking Association.

In his speech, Bailey stressed that "significant improvements" had been made to the rate since it became regulated in April 2013, and that the regulator had no suspicion of "further wrongdoing" in relation to the rate. Rather, the market for unsecured interbank lending, on which LIBOR is based, is "no longer sufficiently active" for the rate to be based on actual transaction data, raising "a serious question" about the sustainability of the rate.

"In our view it is not only potentially unsustainable, but also undesirable, for market participants to rely indefinitely on reference rates that do not have active underlying markets to support them," Bailey said in his speech. "As well as an inherently greater vulnerability to manipulation when rates are based on judgements rather than the real price of term funding, there are a host of questions about whether and how such reference rates can respond to stressed market conditions."

A shift away from reliance on LIBOR would require amendments to legacy contractual terms making reference to the rate, something which panel banks have told the FCA would take a minimum of between four and five years, Bailey said. The FCA would therefore continue to support the rate, including through its power to compel banks to submit to LIBOR if necessary, for this length of time, he said.

After this point, it would be up to the IBA and the panel banks to decide whether they wished to continue to produce LIBOR on the same basis as at present "if they wanted to, and were able to do so". However, publication could not and would not be guaranteed by the regulator, Bailey said.

The FCA intends to work with the industry to promote the use of alternative benchmarks based on actual transaction data, such as the Sterling Overnight Index Average (SONIA), which is now administered by the Bank of England, Bailey said.