LIBOR Insights
This article is written by Silla Brush and William Shaw for Bloomberg News
Britain’s financial-market watchdog urged companies to take basic steps to prevent a cliff-edge scenario when the discredited LIBOR benchmark expires by the end of 2021, warning them of “huge risks” if they don’t.
Firms must commit to incorporating fallback language into their contracts so they can transition smoothly from LIBOR into replacement rates, said Edwin Schooling Latter, director of markets and wholesale policy at the Financial Conduct Authority.
The plan is emerging as a key way for firms to accomplish the move off LIBOR, which still underpins hundreds of trillions of dollars worth of financial assets worldwide.
“I and others question the plausibility of relying on ringing round dealers to offer substitute rates. You could be left with a contract that no longer works,” Latter said in a recent speech, adding firms should sign on to a protocol from the International Swaps and Derivatives Association in the coming months that will help companies switch into LIBOR’s replacement rates.
“Not signing the protocol therefore seems a huge risk to take,” he said. “We don’t think financial firms can afford to take that risk for themselves or for their clients, or for the wider financial system.”
Regulators began phasing out the LIBOR benchmark after European and U.S. banks were found to have manipulated rates to benefit their own portfolios, with lenders and companies supposed to make the leap over the next 18 months. Yet those efforts have stumbled as market participants shifted attention away from the transition and toward surviving the COVID-19 crisis.
Boilerplate terms can help firms switch to alternatives such as the Secured Overnight Financing Rate in the U.S., even if they haven’t drawn up transition plans. Critically, an industry-wide convention would spare the costs of extensive contractual negotiations.
To be sure, fallback language isn’t a miracle solution. It depends on whole sectors embracing it in order to work, according to Gennadiy Goldberg, senior U.S. rates strategist at TD Securities in New York. Thus, it might help with cleared derivatives but not necessarily with those that don’t go through clearing.
But analysts say it’s probably a step in the right direction.
“It’s a way to get a significant portion of the market onto one standard and one set of exposures so as to decrease the level of complexity across the board,” Goldberg said.
Regulators may announce as soon as “the final weeks of this year” their decisions on what will happen to the various LIBOR settings at the end of 2021, according to Latter.
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