FCA Chief Executive Says LIBOR Is Unsustainable
In a speech at Bloomberg London, UK Financial Conduct Authority ("FCA") Chief Executive Andrew Bailey discussed (i) the sustainability of the London Interbank Offered Rate ("LIBOR"), (ii) a target date for the cessation of FCA support for LIBOR, and (iii) planning for an orderly transition.
According to Mr. Bailey, the FCA concluded that it is "not only potentially unsustainable, but also undesirable, for market participants to rely indefinitely on reference rates that do not have active underlying markets to support them." Despite efforts to improve governance and anchor LIBOR submissions to actual transactions, he noted, the inactivity of markets that LIBOR seeks to measure has made it difficult to maintain a rate that accurately represents market conditions. Because of this, he said, even a well-run benchmark is unable to measure a "market [that] does not exist."
Mr. Bailey stressed the need for a transition period in which to mitigate risks that otherwise could occur if the change was more immediate. Accordingly, he announced the FCA's intention to work to sustain LIBOR through 2021, and to facilitate a market transition during that period in order to allow the FCA to withdraw support after that date.
The FCA will support and facilitate the efforts of market participants to prepare sufficiently for the change. Mr. Bailey stated that panel banks supported the planned transition period by a "wide consensus," and that the FCA asked panel banks to continue submitting contributions to the benchmark voluntarily throughout the period. At the same time, he said, the FCA is cognizant of potential panel degradation, and would consider compelling banks to continue with submissions if necessary.
Mr. Bailey emphasized the need to begin transition efforts towards transaction-based benchmarks:
"Work must therefore begin in earnest on planning transition to alternative reference rates that are based firmly on transactions. Panel bank support for current LIBOR until end-2021 will enable a transition that can be planned and can be executed smoothly. The planning and the transition must now begin."
Commentary
The intent of Britain's financial regulator is to eliminate LIBOR as a benchmark interest rate in favor of a yet to-be-determined substitute reference rate. It is not clear how this change will affect the myriad of contracts tied to LIBOR. For new contracts that reference or would reference LIBOR, firms will need to consider a backup reference rate. As to existing contracts, firms will have to conduct an inventory of affected contracts and consider what provisions those contracts make for the replacement of LIBOR.