Large legacy of contracts stutters Libor transition

Libor is in the process of being phased out and will be replaced by SONIA in April this year.

A legacy of contracts is hindering the progress of the transition from the Libor benchmark, according to the chief of the UK’s financial watchdog.

Speaking at a lecture hosted by the International Capital Market Association, chief executive of the Financial Conduct Authority (FCA) Andrew Bailey, said it has been impractical to change reference rates for certain contracts.

“It is all very well to talk about a future with new benchmarks, and one that importantly matches closely to interest rate risk, but what about the very large legacy of contracts? There will be cases where it is not practical or economic to change reference rates,” Bailey said.

Libor has been shrouded in controversy following a string of allegations of conspiracies and penalties from banks for rigging rates. Around 20 major banks have been caught up in court cases and investigations to do with benchmark manipulation.

Some of the largest European and UK-based investment banks were found to have manipulated the benchmark, including Deutsche Bank, Lloyds Banking Group and Barclays, who were eventually fined a combined total of £391.5 million.

The FCA and the Bank of England decided to phase out Libor after stating it was no longer a suitable benchmark following a decline in activity, proposing to replace Libor with the Sterling Overnight Index Average (SONIA) in April this year.

In November 2017, 20 banks agreed to continue making submissions to Libor until 2021 to ensure a smooth transition as the benchmark was phased out.

“My best guess is that some panel banks would already have departed were it not for the voluntary agreement to stay in until the end of 2021 that we were able to obtain,” Bailey added.

“The ICE Benchmark Administration has opened up the prospect of a voluntary arrangement to sustain Libor after the end of 2021. I don’t rule this out, but I would stress that I don’t see a prospect of a reversal in the decline of the market activity that Libor seeks to measure.”

Bailey concluded that it could also be possible to produce a form of Libor proxy to satisfy the legal definition and serve as a legacy benchmark.