We will start with the conclusion prior to describing what took place in June. The conclusion is that the LIBOR transition is not slowing down as many were expecting due to COVID-19, but rather it is speeding up with more definitive timelines. Members should be proactive in their LIBOR transition efforts and be testing their operational readiness for LIBOR cessation. If there are questions on this news or any other LIBOR-related questions, please contact your Federal Home Loan Bank.
June was eventful to say the least in the LIBOR transition world. Risk.net held a Virtual LIBOR Week conference. An important panel participant was Edwin Schooling Latter, the head of Markets Policy at the Financial Conduct Authority. He stated in one panel discussion that he believed only 10 percent of the U.K. market would utilize a term SONIA rate. Later panels commented that they believe that the U.S. market would be a much larger user of this rate due to consumer loans and mortgage products.
The second event of the week was the announcement by the Chancellor of the Exchequer stating that there would be a proposed amendment to the Benchmark Regulation in regards to the power of Financial Conduct Authority concerning the 35 different LIBORs (various currencies and tenors) they currently regulate.
Some would argue that the Financial Conduct Authority already has the powers that are being legislated and that this is more of a clarification of their powers. This legislation was meant to assist those contracts that the U.K. terms “tough legacy contracts”. These are contracts that are not easily amended or transitioned and do not contain fallback language or trigger language.
To summarize the proposed legislation, the Financial Conduct Authority would have the power to determine that any particular LIBOR is no longer representative of the market. For contracts that fall under ISDA proposed protocols or that utilize the Federal Reserve’s Alternative Reference Rate Committee fallback language, the date a statement determining non-representativeness is announced would be the date that the SOFR adjustment spread calculation would be set.
Specifically, the legislation would allow the Financial Conduct Authority to determine that an entire set of LIBOR rates or a particular LIBOR rate is non-representative. The Financial Conduct Authority would have the power to instruct the LIBOR administrator (ICE) to change the manner in which the particular LIBOR is constructed or calculated to protect market integrity and/or consumers. This would not restore the representativeness of the index. The Financial Conduct Authority would allow the use of the modified LIBOR for tough legacy contracts. It is expected that this legislation will pass.
There are several unknowns for the US market. The Federal Reserve has not made any statement and it cannot be assumed that the U.K. solution would be an acceptable or feasible idea for U.S. dollar LIBOR. If a LIBOR calculation that has been changed by the Benchmark Administrator, at the direction of the Financial Conduct Authority, continues to be utilized there is a high probability of a legal challenge as this is not the original LIBOR index envisioned in the contract. The simple declaration of non-representativeness could trigger fallback language if it has been incorporated into legacy contracts or in new contracts. This would move the U.S. market LIBOR transition clock forward sooner than December 31, 2021. This is not a free pass for the market to utilize “zombie” LIBOR.
Another comment by Edwin Schooling Latter this week, was that the Financial Conduct Authority will announce in the November/December 2020 time frame the definitive intention to cease LIBOR at the end of 2021. He does not anticipate that any of the panel banks will want to voluntarily continue to contribute to LIBOR fixing after the end of 2021. He also recommended that market participants adhere to the ISDA Fallback Language Protocol within four months of its publication. The ISDA Protocol is in its final stages of preparation and according to ISDA’s most recently published timeline could be published as early as July depending on the timing of Department of Justice signoffs.
Another piece of news this week was that the Securities and Exchange Commission Office of Compliance and Examination of Registrants will be adding LIBOR transition readiness and disclosures to their list of examination topics.