LIBOR transition – clarity on the path forwards

On 5 March 2021, the UK Financial Conduct Authority (FCA) made a key announcement about the future cessation or loss of representativeness of each of the 35 LIBOR benchmark settings currently published by ICE Benchmark Administration Limited (IBA). 

This blog post summarises the FCA's announcement.

Permanent cessation

Immediately after 31 December 2021, the following settings will cease permanently:

• overnight, one-week, two-month and 12-month sterling LIBOR;
• Spot Next, one-week, two-month and 12-month Japanese yen LIBOR;
• one-week and two-month US dollar LIBOR;
• all seven euro LIBOR settings; and
• all seven Swiss franc LIBOR settings.

Immediately after 30 June 2023, overnight and 12-month US dollar LIBOR settings will cease permanently.

Synthetic LIBOR/unrepresentativeness

• For one-, three- and six-month sterling LIBOR settings, the FCA will consult on requiring IBA to continue to publish these settings based on a 'synthetic' methodology for an additional period after the end of 2021, using new powers proposed under the Financial Services Bill (currently making its way through the UK Parliament). The expectation is that these synthetic sterling LIBOR rates will be based on a forward looking term SONIA rate plus a fixed credit spread adjustment. However, the FCA has clarified that LIBOR settings published on a synthetic basis will no longer be representative of the underlying market and the economic reality those settings were intended to measure. Synthetic LIBOR rates are intended for use in 'tough legacy' contracts only. Consequently, there will be restrictions on the use of synthetic LIBOR rates by UK-supervised entities from 1 January 2022, subject to the proposals contained in the Financial Services Bill becoming law.  
• For one-, three- and six-month Japanese yen LIBOR settings, the FCA will consult on requiring IBA to continue to publish these on a synthetic basis for one additional year. The FCA has indicated that publication of these settings would then cease permanently after 30 December 2022. Again, the synthetic rates will not be considered representative, so there will be restrictions on use by UK supervised entities from 1 January 2022.
• For one-, three- and six-month US dollar LIBOR settings, the FCA will continue to consider the case for requiring IBA to continue publishing these on a synthetic (but non-representative) basis after the end of June 2023.

The FCA’s announcement was triggered by a notification received from IBA, following completion of IBA’s consultation on cessation of the publication of LIBOR settings, that IBA intended to cease providing all LIBOR settings for all currencies (subject to any rights of the FCA to compel IBA to continue publication). 

IBA published an accompanying feedback statement on its consultation on 5 March 2021. IBA stated that as a consequence of not having access to input data required to calculate LIBOR settings on a representative basis beyond the proposed cessation dates, it will cease publication of all LIBOR settings after end of 2021, with the exception of some US dollar LIBOR tenors which will continue until end of June 2023.

Implications of the announcement

This announcement has not come as a surprise to the financial markets – it was expected and has been widely welcomed. The message from the UK regulators has been clear for some time – market participants need to transition away from LIBOR use by the end of 2021 – and significant progress has been made towards this transition.

Even so, the FCA announcement has important implications.

• Market participants now have a clear picture of when the various LIBOR settings will cease to be published, at least on a representative basis, and confirmation that the FCA does not expect any LIBOR setting to become unrepresentative prior to the relevant dates set out above. There is also a little more clarity on the FCA’s intentions relating to the production of synthetic LIBOR rates.
• The announcement will have direct implications for certain contracts.

Fundamentally important for the OTC derivatives market, the FCA announcement constitutes an index cessation event under the ISDA 2020 IBOR Fallbacks Protocol and IBOR Fallbacks Supplement ('the ISDA IBOR Fallbacks') (see this statement from ISDA). This means that the fallback 'spread adjustment' published by Bloomberg will be fixed as at 5 March 2021 for all LIBOR settings (see this notice from Bloomberg).

The relevant replacement rates as set out in the ISDA IBOR fallbacks will most likely actually apply from the first London banking day on or after:

• 1 January 2022 for all seven euro LIBOR settings, all seven Swiss franc LIBOR settings, all seven Japanese yen LIBOR settings and all seven sterling LIBOR settings; and 
• 1 July 2023 for all seven US dollar LIBOR settings (given the provision of certain US dollar LIBOR settings until 30 June 2023, allowing for interpolation of rates). 

Not all OTC derivatives will be subject to the ISDA IBOR Fallbacks, but the effect of this will be felt throughout the OTC derivatives market, in particular in relation to pricing. 

In the bonds market, there may be some outstanding sterling LIBOR linked floating rate notes which contain fallbacks which will be triggered by this announcement (although we expect the numbers of notes with such fallbacks to be relatively small).

For loans, the FCA announcement and the accompanying statement from IBA could have potential implications and parties should analyse their documentation. LIBOR cessation triggers are contained in LMA style loan agreements with the replacement of screen rate provisions or with rate switch mechanics, but definitions may vary from deal to deal. The FCA announcement and IBA statement could trigger the option for parties to agree new risk-free rate (RFR) linked mechanics with lower lender consent thresholds, or constitute a 'rate switch trigger event' in loan agreements containing hardwired provisions to facilitate a switch to new RFR-linked pricing. Typically the switch to the new RFR occurs once LIBOR actually becomes unrepresentative or permanently ceases, although many LMA style agreements also contain bespoke backstop provisions.

The ARRC has confirmed that, in its view, the FCA announcement and IBA statement constitutes a 'benchmark transition event' under the ARRC proposed hardwired language with respect of US dollar LIBOR settings and has published FAQs on this topic. This trigger event is included in loan documents containing the ARRC recommended fallback language for US dollar LIBOR to transition to SOFR, although the consequence of the trigger does not mean anything happens in the near term. Under ARRC fallback language, there is no set period and the SOFR replacement rate would not become effective until a certain number of days (typically 90) before the cessation of US dollar LIBOR for that tenor (which, for most US dollar LIBOR tenors, will be 1 April 2023).

Remaining uncertainties

However, some significant 'known unknowns' remain, particularly in relation to transitioning of so-called 'tough legacy' contracts.

Focussing on the UK market, it is still uncertain how the FCA will define 'tough legacy' contracts, which will determine whether UK supervised entities will be allowed to use synthetic sterling LIBOR rates in legacy contracts. The FCA will consult on this in Q2 2021. 

Another unknown is whether parties to legacy contracts will be willing to live with such contracts referencing synthetic LIBOR rates in place of panel bank LIBOR rates rather than proactively amending the relevant contracts. In some cases, for English-law-governed contracts, this could depend on whether statutory contract continuity and safe harbour provisions to support the use of synthetic LIBOR are set out in UK law – a point on which HM Treasury are currently consulting the market.

Considering international co-ordination, there remains some concern around how the different proposed legislative solutions in the UK, US and EU will work together with respect to legacy contracts and whether the different approaches may contradict one another, leave gaps, or just generally create uncertainty. Authorities internationally have sought to reassure the market that they are working closely together to ensure that this is avoided. For more information on New York’s proposed legislation, see our blog post.

Path forwards

In summary, this FCA announcement creates welcome clarity on the path of transition from LIBOR to RFRs. The message from the Bank of England and the FCA remains clear: market participants should act now to proactively complete transition prior to the end of 2021, and regulated firms (and therefore indirectly all borrowers from, and issuers working with, regulated firms) will be facing further pressure from their supervisors to assist with the transition.