28 January 2019

FCA: LIBOR transition and contractual fallbacks

Highlights:

• On a monthly basis, cleared notional in Sterling Overnight Index Average (SONIA) swaps is now higher than that for sterling London Inter-bank Offered Rate (LIBOR).
• The best and smoothest transition from LIBOR will be one in which contracts that reference LIBOR are replaced or amended before fallback provisions are triggered.
• Market participants should not rely on the availability of an option to use Libor for legacy contracts.

It is important that trigger events are clear and unambiguous. Cessation of publication has intuitive appeal in that regard. Clearly there should be a cessation trigger. The process of cessation may not be straightforward – it could involve an undetermined period in which the rate is published, but not representative, or even a period when the published LIBOR rate is a fixed one. A regulator’s announcement that the representativeness test will no longer be satisfied upon the date of a forthcoming departure of a particular bank or set of banks could offer a suitably clear and precise additional and alternative event on which to activate a trigger. The FCA is mindful that contracts could therefore choose to include a trigger based on such an announcement. FCA is also clear on the consequent responsibilities FCA would have to ensure that any such announcement is communicated to the whole market in an appropriate manner with appropriate clarity. 

Mr Latter hopes that his remarks have identified issues to think about in the important next stages in the design of contractual fallbacks, and how they are triggered.

One thing he cannot provide is certainty about what the end-game for LIBOR will look like. There is uncertainty. That means uncertainty for those who continue to hold or write contracts that reference LIBOR. This continued uncertainty is one reason why FCA continues to urge those still creating new contracts that reference LIBOR, and have a contract life beyond end-2021, to move rapidly instead to the new RFRs whose continued publication beyond that date can be relied upon.

Having the right fallback triggers means having the right safety belt. But, as Andrew Bailey said last July, the best transition will be one in which that safety belt is never needed. That’s why the progress he reported on the development of new markets based on the RFRs is so welcome. It is why efforts are so focused on securing transition before fallbacks are needed. And it is why market participants must implement their transition plans too.

Full speech

© FCA - Financial Conduct Authority