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From Securities Regulation Daily, July 28, 2017

FCA chief calls for phase-out of LIBOR by the end of 2021

By John Filar Atwood

LIBOR benchmarks are not sustainable and should be phased out by the end of 2021, according to U.K. Financial Conduct Authority (FCA) Chief Executive Andrew Bailey. The industry must transition to alternative reference rates that are based on transactions not judgments, he said, and a multi-year phase-out will lower the potential risks and costs of that transition.

In remarks at a Bloomberg London event, Bailey emphasized that the call for the end of LIBOR is not related to actual or suspected misuse of the benchmark. Rather, it is because of the absence of a sufficiently active market underlying LIBOR.

LIBOR—the London Interbank Offered Rate—is the annualized, average interest rate at which a select group of large, reputable banks (panel banks) that participate in the London interbank money market can borrow unsecured funds from other banks. According to data from the ICE Benchmark Administration (IBA), Bailey noted, there are relatively few eligible term borrowing transactions by any large banks anymore.

The absence of active underlying markets raises a serious question about the sustainability of the LIBOR benchmarks that are based on those markets, Bailey said. If an active market does not exist, a benchmark cannot measure it, he noted, and panel banks are uneasy about providing submissions based on judgments with little actual borrowing activity against which to validate those judgments.

Persuading panel banks. The FCA has spent considerable time in recent years persuading panel banks to continue submitting to LIBOR, Bailey noted. The regulator has been concerned that withdrawal of panel banks would weaken the robustness of the rate, and that if one or more banks leave, other panel banks will follow suit.

He expressed his appreciation to those panel banks that have continued their submissions despite their discomfort. He noted that the FCA has the authority to compel banks to contribute to LIBOR, if necessary, but it does not think it is right to ask or force panel banks to submit their judgments indefinitely.

The FCA also believes it is undesirable for market participants to rely indefinitely on reference rates that do not have active underlying markets, according to Bailey. In addition to greater vulnerability to manipulation when rates are based on judgments rather than the real price of term funding, there are questions about whether the reference rates can respond to stressed market conditions, he said.

Transition. Some steps towards a transition away from LIBOR have recently been taken, Bailey noted, including the consensus that has been reached among derivative market participants on the preferred alternative reference rates. In addition, the U.K.’s Risk Free Rate Working Group recently selected reformed SONIA as its proposed alternative benchmark, and the Alternative Reference Rates Committee in the U.S. announced its choice of a broad Treasuries repo rate.

Bailey pointed out that both of the newly chosen benchmarks have the benefit of being anchored in significantly more active markets than LIBOR, and neither involves expert judgment. In both cases, issues about fairness with regard to who is on or is not on panels become irrelevant as transaction information is collected from all relevant market participants by central banks, he added.

Timing. Bailey said that the FCA has spoken in recent months with the 20 panel banks that currently sustain and rely on LIBOR, as well as central banks and other regulators about how much time would be required for an orderly transition away from the current widespread use of LIBOR. The consensus answer was that LIBOR is so pervasive, and used for so many different purposes in so many jurisdictions, that several years would be needed. Most respondents thought the transition would be a challenge but could be achieved within four or five years, but not less, he noted.

The FCA firmly believes that work on a transition away from LIBOR is unlikely to begin in earnest if market participants continue to assume LIBOR will last indefinitely, Bailey said. He noted that in Switzerland it has been clear for some time that the existing reference rate would not survive, but serious work on a transition to a new rate did not begin until a firm date for discontinuation of the outgoing reference rate was set.

According to Bailey, the FCA has received widespread support from the current panel banks to sustain LIBOR voluntarily until the end of 2021. The date is far enough away to reduce the risks and costs of a more sudden change, he stated, and to give market participants time to engage as many counterparties and LIBOR users as is possible in the transition planning.

The FCA’s intention, Bailey said, is that at the end of 2021 the FCA will no longer have to persuade or compel banks to submit to LIBOR. As a result, it will not be necessary for the FCA to sustain the benchmark through its influence or legal powers, he added.

After 2021. What happens toLIBOR after 2021will be up to IBA, the benchmark’s administrator, and to the panel banks, Bailey noted. They could continue to produce LIBOR if they choose to, he said, but the benchmark would no longer be sustained through the mechanism of the FCA persuading or obliging panel banks to stay.

As for legacy contracts that still reference LIBOR after 2021, their fate depends on whether panel banks choose to continue to produce LIBOR, according to Bailey. It also depends on the preparations that LIBOR users make to either switch contracts from the current basis for LIBOR or ensure their contracts have adequate fallbacks if LIBOR did cease publication.

Bailey reiterated that the move to transaction-based benchmarks cannot occur if markets continue to rely on LIBOR in its current form. He urged market participants to begin in earnest to plan their transition to alternative reference rates.

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