On 27 July 2017, Andrew Bailey, Chief Executive of the FCA, delivered a speech on “The Future of LIBOR”, in which he confirmed that discontinuation was targeted for the end of 2021.
In his speech, Mr Bailey referred in passing to recent scandals – extensively reported in the press – the current negative perception of LIBOR as a result. He also noted the significant improvements, including a “step change in the quality of governance” around submissions, to the benchmark implemented as a result.
Quite apart from its recent history, however, Mr Bailey’s speech focused on the sustainability of the LIBOR benchmark and its suitability as a genuine representation of market conditions given the current low level of activity in the market for unsecured wholesale term lending to banks – i.e. the market that LIBOR is designed to measure and reflect. While confirming that the FCA is still gathering its own data on exact volumes, Mr Bailey pointed to data held by the ICE Benchmark Administration – the administrator of LIBOR – and central banks indicating “relatively few eligible term borrowing transactions by any large banks” and noted that there was little prospect of activity levels changing substantially in the future.
If the market does not exist then, how can it be measured?
Mr Bailey noted that LIBOR is currently sustained by the use of “expert judgement” by panel banks, a process which itself causes discomfort amongst those banks. The FCA has persuaded panel banks to continue to submit, however, in order to preserve as far as possible the representativeness and robustness of the benchmark, and to avoid widescale market disruption from deterioration in both.
The long sail
The FCA’s efforts to sustain LIBOR are an attempt to manage and control the transition to an alternative benchmark by the end of 2021. Mr Bailey noted that it was both unsustainable and undesirable to have reliance on a benchmark without an underlying market to support it.
Mr Bailey provided examples of other reference rates now being used in the market, underpinned by active markets and with no requirement for “expert judgement”, i.e. SONIA, EONIA, SARON and TONAR. However, the FCA’s key message is that transition should be planned and orderly – and will take time – with no one of the existing benchmarks identified in the speech as a substitute or potential substitute for LIBOR.
The date proposed by the FCA for discontinuation of LIBOR – circa. 4 years in the future – is an effort by the FCA, with the agreement of panel banks, to focus minds on the transition to a new benchmark that may lend itself to debt markets as prevalently as LIBOR has to date. The longer lead in time is also intended to reduce risks, costs and disruption characteristic of a sudden change.
In the meantime…
The clear signposting of likely discontinuation is a positive step by the FCA. It allows time for existing debt documentation to be reviewed and consideration to be given to potential amendments that may be required, as well as when and how best to effect those in a controlled manner. That review will, we fully expect, be undertaken at bank if not industry level and, particularly given the remaining length of the voyage ahead, we see no reason to commence any separate review now on an individual document or relationship basis.
However, for parties embarking on a new transaction or entering into new debt documentation with a term stretching beyond 2021, and where pricing is initially tied to LIBOR, it is worth being aware of the probability, based on the FCA’s intent, that the pricing mechanism will change throughout that term. We would advise that lenders, borrowers and professional advisers engage in regular conversations between now and the end of 2021 and updates on current thinking are communicated clearly and timeously, in order that all parties may plan accordingly.
The full text of Mr Bailey’s speech can be found here: The future of LIBOR