The Working Group on Sterling Risk-Free Reference Rates has opened a consultation on credit adjustment spread methodologies for fallbacks in cash products referencing GBP LIBOR. The consultation focuses on cash products, including, but not limited to, syndicated loans, floating rate notes, retail loans, bilateral corporate loans and securitizations. It only covers GBP LIBOR and credit adjustment spreads to be applied to a SONIA-derived rate. Responses to the consultation can be submitted until February 6, 2020.
The U.K. Financial Conduct Authority has announced that it will no longer compel submissions to LIBOR after 2021. Various alternative near risk-free rates have been developed to replace LIBOR, such as SONIA for GBP LIBOR. Work on including robust fallbacks in contracts referencing LIBOR that will mature after the end of 2021 is ongoing. The RFRs are not economically equivalent to LIBOR and therefore need to be adjusted to account for: (i) the RFR is an overnight rate and not a term rate; and (ii) the various premia included within LIBOR, such as a term liquidity premium and a bank credit risk element. The credit adjustment spread is required to minimize the economic impact of the transition from LIBOR to the RFRs.
The objective of the consultation is to assist cash market participants to consider the appropriate methodologies for credit adjustment spreads in the cash markets for: (i) fallbacks that operate on the cessation of LIBOR; and (ii) fallbacks that operate before the cessation of LIBOR and are triggered as a consequence of a regulatory announcement of non-representativeness of LIBOR. The Working Group notes that consultations of the International Swaps and Derivatives Association, covering the derivatives markets, resulted in a majority of respondents preferring a historical median over a five-year lookback period for calculating credit adjustment spread for fallbacks on cessation of LIBOR. The Group acknowledges that there may be benefits for the cash markets in adopting the same methodology, but stresses that thought needs to be given as to whether there are differences to take into account between the fallback rate in cash products and in the derivatives market. Notably, the Working Group's proposals do not cover term rate adjustments and it is assumed that cash market participants will instead reference term versions of the overnight RFRs directly.
The outcome of the Working Group's consultation will not be binding on market participants, however, it is intended to assist the market in developing accepted methodologies for the cash markets.
View the consultation paper.