How tough is Tough Legacy? FCA announcement on synthetic LIBOR

30 September 2021

Phil LloydManaging Director, Head of Customer Sales Delivery

View bio

John Stevenson-HamiltonLIBOR Client Strategy & Engagement

View bio

Other insights

View more insights

On 29 September the FCA1 announced that 1) they will require benchmark administrators to publish a ‘synthetic LIBOR2 rate’ post cessation during 2022 for Sterling & Yen, and 2) they are launching a consultation on permitted uses of these synthetic rates.

So, what does this mean, and any surprises?

First a disclaimer....the announcement was made this morning and the proposals around restrictions on use are a consultation (closing 20 October), so we do need to see results of that before all is confirmed. Below is just our first take given what has been said so far.

Did we see this coming?

The fact that there would be a synthetic rate for Sterling LIBOR based on Term SONIA3 plus a fixed credit adjustment spread published by ICE4 is no surprise. Industry was expecting an announcement before the end of Q3, so that is no great reveal. 

And just to blow our own trumpet, we did predict this back in October 2019 with “LIBOR on the ropes but when is the knockout blow?, scroll down to ‘What to do with tough legacy’ to look at our crystal ball.

What is more interesting is the consultation around the permitted use(s) of the synthetic rate. Back in the day (May 2020) the £RFR Working Group5 produced a paper on Tough Legacy setting out some expectations, but fair to say mood music from official sector has until now been muted. General line has been “don’t rely on tough legacy to solve your problems, get fallbacks and active transition in place asap”.

And in fairness this has been a sound approach that has kept focus on transition until now, and certainly in the derivatives space has resulted in the vast majority of positions now having robust fallbacks. But we sense a change in tone now - there is still the statement in the press release “Users of LIBOR should continue to focus on active transition rather than relying on synthetic LIBOR” but that said, there is a clear acknowledgement that to avoid market disruption the authorities will permit a wide range of legacy LIBOR contracts in GBP & JPY to reference the synthetic rates post-cessation:

“At least for the duration of 2022, the FCA is proposing to permit legacy use of synthetic sterling and Japanese yen LIBOR in all contracts except cleared derivatives.”

That last bit is interesting... it looks like loans (bilateral & syndicated), bonds, securitisations and remaining bilateral derivatives that have no fallbacks will all be eligible to reference the synthetic LIBOR rate, at least in the immediate future following 1 January 2022. 

The notice the FCA sent to ICE on 10 September is instructive in understanding the reasons behind the decision to compel them to publish the synthetic rate, and the likely outcome of the consultation. They anticipate a ‘material proportion’ of the current Sterling LIBOR exposure of £472bn will remain outstanding at year end (even following fallbacks and planned transition activities). Without a tough legacy solution “widespread market disruption and a disorderly cessation would likely be caused”.

So, we can relax, Christmas isn’t cancelled?

Well, there is more breathing space to re-negotiate those final LIBOR contracts (assuming the consultation goes through as proposed) but the authorities are very much pressing market participants to get on and finish the job. They are only promising a published legacy rate through 2022 (JPY confirmed as only 2022, GBP to be reviewed annually), and reserve the right to tighten restrictions on who may and may not use that rate on legacy contracts through the year.

And on relaxing in the run up to Christmas, anyone involved in the transition activities for Clearing Houses, or the implementation of fallbacks will still have plenty on their plate other than turkey.

And what about USD?

The other thing announced today was a re-iteration of the controls around no new USD LIBOR from 1 January 2022 onwards (except for risk management purposes in the case of derivatives). This isn’t a surprise, and links through to the statement by the Fed back in November last year. Only thing of note is that unlike the milestone controls for GBP LIBOR this year, for USD LIBOR they are not even allowing new transactions that mature before June 2023 to be executed after January 2022, unless they meet the hedge exception criteria.

So subject to confirmation of the outcome of the consultation in October (and we can’t imagine many in the industry will challenge the FCA’s general direction of travel here), there will be a little more wriggle room for those last contracts that have not got over the line yet. But not too much. 

 

1

FCA

Financial Conduct Authority

2

LIBOR

London Interbank Offered Rate

3

SONIA

Sterling Overnight Interbank Average Rate

4

ICE

Intercontinental Exchange, Inc

5

£RFR Working Group

Working Group on Sterling Risk-Free Reference Rates

Regulation
LIBOR
SONIA


This article has been prepared for information purposes only, does not constitute an analysis of all potentially material issues and is subject to change at any time without prior notice. NatWest Markets does not undertake to update you of such changes.  It is indicative only and is not binding. Other than as indicated, this article has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty, undertaking or assurance of any kind, express or implied, is made as to the adequacy, accuracy, completeness or reasonableness of the information contained in this article, nor does NatWest Markets accept any obligation to any recipient to update or correct any information contained herein. Views expressed herein are not intended to be and should not be viewed as advice or as a personal recommendation. The views expressed herein may not be objective or independent of the interests of the authors or other NatWest Markets trading desks, who may be active participants in the markets, investments or strategies referred to in this article. NatWest Markets will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser; nor does NatWest Markets owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on NatWest Markets for investment advice or recommendations of any sort. You should make your own independent evaluation of the relevance and adequacy of the information contained in this article and any issues that are of concern to you.

This article does not constitute an offer to buy or sell, or a solicitation of an offer to buy or sell any investment, nor does it constitute an offer to provide any products or services that are capable of acceptance to form a contract. NatWest Markets and each of its respective affiliates accepts no liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this material or reliance on the information contained herein. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not be lawfully disclaimed.

NatWest Markets Plc. Incorporated and registered in Scotland No. 90312 with limited liability. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. NatWest Markets N.V. is incorporated with limited liability in the Netherlands, authorised and regulated by De Nederlandsche Bank and the Autoriteit Financiële Markten. It has its seat at Amsterdam, the Netherlands, and is registered in the Commercial Register under number 33002587. Registered Office: Claude Debussylaan 94, Amsterdam, the Netherlands. Branch Reg No. in England BR001029. NatWest Markets Plc is, in certain jurisdictions, an authorised agent of NatWest Markets N.V. and NatWest Markets N.V. is, in certain jurisdictions, an authorised agent of NatWest Markets Plc. NatWest Markets Securities Japan Limited [Kanto Financial Bureau (Kin-sho) No. 202] is authorised and regulated by the Japan Financial Services Agency. Securities business in the United States is conducted through NatWest Markets Securities Inc., a FINRA registered broker-dealer (http://www.finra.org), a SIPC member (www.sipc.org) and a wholly owned indirect subsidiary of NatWest Markets Plc.

Copyright 2021 © NatWest Markets Plc. All rights reserved.