FCA signals death knell for LIBOR
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On 27 July 2017, Andrew Bailey, chief executive of the Financial Conduct Authority, announced that LIBOR should be phased out by the end of 2021. The announcement puts a sunset date on plans already under way, both in the UK and the US, for the long-standing benchmark to be replaced. In April 2017 a Bank of England press release stated that, as part of the Financial Stability Board's wider interest rate benchmark reform agenda, its working group on sterling risk-free reference rates had decided on SONIA as its preferred near risk-free interest rate benchmark (RFR) for use in sterling derivatives and other financial contracts.
On 15 June 2017 Scott O'Malia, Chief Executive at ISDA gave a speech about its progress in taking forward initiatives to establish alternative RFR benchmarks and the development of fallback rates for key interbank offered rates (IBORs). ISDA conceded that, given jurisdictions were only starting to choose alternative rates, there is a lack of information on the steps towards using alternative rates or establishing a transition programme, although it did set out some guiding principles for benchmark transition. Separately ISDA also confirmed that there is an industry working group looking at how to approach forthcoming EU benchmark Regulation requirements to include provisions in documentation where benchmarks cease to exist or are materially altered.
On 29 June 2017, the Bank of England RFR working group published a white paper on potential approaches to a broader adoption in sterling markets of the SONIA benchmark. The white paper closes to feedback on 29 September 2017 after which the working group would be expected to publish a summary.
As such the FCA's announcement perhaps serves to crystallise the idea that LIBOR is coming to an end and to focus the attention of market participants as to the need for transitional arrangements. In this regard, and leaving aside the EU Benchmark Regulation requirements, current successor provisions may not be up to the job. Normal rules of contractual interpretation applied to current industry documentation would probably accommodate LIBOR's demise to some extent, but in ISDA-documented swap contracts, for example, the relevant ISDA definitions do not expressly provide for IBOR discontinuance – merely for what happens if the source page and/or source sponsor (but not the source rate itself) disappears. In LMA-documented loan agreements, drafting intending to future proof the use of benchmark rates does not specifically provide for complete IBOR discontinuance but rather for changes to the calculation process and the use of fallback rates (including reference bank rates). As for bespoke contracts, it will be necessary to check the relevant interest rate calculation provisions on a document by document basis.
It remains to be seen how the markets will address these issues. Given the number of contracts that will be affected, we would not be surprised if the derivatives markets were to adopt the familiar protocol solution. Protocol solutions have not previously been seen in the loan markets and are unlikely to provide a total solution in any event. We would, in any event, expect the issue of LIBOR discontinuance to be addressed on an ad hoc basis in all new loan contracts going forward, at least for longer-dated deals and pending the adoption of appropriate fallback or replacement rate provisions across industry documentation. With swap documents this is less likely as the market will mostly likely want a "big bang" switch-over to a universal alternative to avoid basis risk between different positions.
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