FCA consults on wind-down of synthetic sterling LIBOR

Summary

On 30 June 2022, the FCA launched a consultation ¹ on the wind-down of synthetic sterling LIBOR and how best to retire the remaining five US dollar LIBOR tenors ². In the consultation, the FCA asks for market participants' feedback on:

• whether it will be possible for synthetic one-month and six-month sterling LIBOR to be discontinued in an orderly fashion on 31 March 2023 (three months later than originally anticipated);
• if not, what alternative timeframe would be preferable;
• when it will be possible for synthetic three-month sterling LIBOR to be discontinued in an orderly fashion;
• whether it will be possible for the market to transition outstanding US dollar LIBOR exposures by 30 June 2023;
• whether the introduction of synthetic US dollar LIBOR in the future would give rise to unintended adverse consequences; and
• whether there are specific contracts or types of contracts that reference any of the synthetic sterling LIBOR or US dollar LIBOR rates and (i) do not contain workable fallbacks, (ii) cannot be transitioned, and (iii) cannot cease prior to maturity without causing disruption.

In the consultation, the FCA also reminds market participants that all synthetic yen LIBOR tenors will be discontinued at the end of 2022.

The consultation closes on 24 August 2022. Feedback will be used by the FCA when deciding when to discontinue the synthetic sterling LIBOR rates and whether or not synthetic US dollar LIBOR will be required after June 2023.

Extra time for synthetic one-month and six-month sterling LIBOR

One-month and six-month sterling LIBOR have been published on a synthetic basis since 1 January 2022, having been designated "unrepresentative" by the FCA under the UK Benchmarks Regulation ³. The synthetic calculation methodology uses ICE Benchmark Administration's Term SONIA Reference Rate and the applicable spread adjustment published by Bloomberg Index Services Limited for use in ISDA fallback rates. Under English law, in-scope contracts and financial instruments that had not transitioned away from sterling LIBOR by the end of 2021 automatically switched to the synthetic version of the contractual LIBOR rate on 1 January 2022. Synthetic LIBOR is only available for use in legacy contracts: no new use is permitted.

The FCA can compel production of synthetic LIBOR for up to ten years, but only intends to do so for as long as is necessary to ensure an orderly wind-down. The FCA previously suggested that production of one-month and six-month sterling LIBOR would continue for one year only, until the end of 2022; however, in the consultation, the FCA proposes continuation of the rates for an additional three months, until 31 March 2023, to give the market sufficient notice of the rates' ultimate demise.

The consultation considers transition progress in the derivatives, bond, securitisation, funds, loans and mortgages/consumer lending markets and concludes in each case that the vast majority of outstanding contracts and financial instruments will have either matured or transitioned by the end of March 2023. The consultation notes that a small number of mortgages reference one-month LIBOR, but that these are very few and transition by the end of March 2023 should be possible.

The consultation asks market participants:

• whether they agree that synthetic one-month and six-month sterling LIBOR can be ceased in an orderly fashion at the end of March 2023;
• whether there are any reasons why transition in this timeframe would not be possible and, if so, what are the reasons and to what contract/instrument type(s) do they relate; and
• what alternative timeframe would be preferable.

What about three-month synthetic sterling LIBOR?

Three-month sterling LIBOR has been published on a synthetic basis since 1 January 2022, using the same calculation methodology as the one-month and six-month tenors.

In the consultation, the FCA recognises that three-month LIBOR is more prevalent than the other sterling tenors, particularly in the consumer market, and that it may therefore require a longer wind-down period. Nevertheless, the FCA reiterates that synthetic three-month LIBOR is a temporary solution and encourages market participants' continued focus on transition.

In the consultation, the FCA asks:

• whether there are reasons why synthetic three-month sterling LIBOR should not be discontinued with the other tenors on 31 March 2023, and, if so, what are the reasons; and
• when is the earliest date on which synthetic three-month sterling LIBOR could be discontinued in an orderly fashion.

The FCA also asks whether there are any specific contracts or types of contracts linked to any of the synthetic sterling rates that do not contain workable fallbacks, cannot be transitioned, and cannot cease prior to maturity without causing disruption, and asks for details about such contracts and the barriers to transition.

And synthetic US dollar LIBOR?

The position with regard to US dollar LIBOR differs from sterling LIBOR, as five US dollar tenors are still in use and will continue on a representative basis until 30 June 2023. Thereafter, overnight and twelve-month US dollar LIBOR will be discontinued and one-month, three-month and six-month US dollar LIBOR will no longer be representative of their underlying market.

Although the US dollar LIBOR rates have not yet ceased, their use in new contracts has been widely restricted since the end of 2021. Under specific US legislation, in-scope US law-governed contracts and instruments referencing an affected US dollar LIBOR rate will automatically switch to a replacement rate based on SOFR after 30 June 2023.

Through the consultation, the FCA wants to gauge the progress of US dollar LIBOR transition and determine whether the introduction of a synthetic US dollar LIBOR rate in the future would give rise to unintended adverse consequences.

The FCA is clear in the consultation that they are not proposing the introduction of a synthetic US dollar LIBOR rate at this stage: however, consultation responses will be used as part of a future assessment as to whether synthetic rates are required. If the FCA determines that one or more synthetic rates is/are required, the calculation methodology would likely be the same as that used for synthetic yen and sterling LIBOR – i.e. an appropriate forward-looking term rate (such as CME Term SOFR) plus the applicable Bloomberg/ISDA spread.

The consultation focuses on non-US markets, as most non-transitioned US law-governed contracts will be remediated under the legislation discussed above, and concludes that the vast majority of outstanding contracts and financial instruments will either have matured or transitioned by the end of June 2023. The consultation asks market participants:

• whether they agree that it is possible to transition remaining US dollar exposures by the end of June 2023;
• whether there are any reasons why transition in this timeframe would not be possible and, if so, what are these reasons and to what contract/instrument type(s) do they relate;
• whether there are any issues relating to non-US and non-UK law governed contracts that might affect transition;
• whether there are any specific contracts or types of contracts linked to US dollar LIBOR that do not have workable fallbacks, cannot be transitioned, and cannot cease prior to maturity without causing disruption, and, if so, why not; and
• what impact the introduction of a synthetic US dollar LIBOR rate would have, and whether there would be unintended adverse consequences.

You can access related briefings via our LIBOR Transition Portal.

Authors: Mike Logie and Kirsty McAllister-Jones

^{1 CP 22/11.}

^{2 Overnight, one-month, three-month, six-month, and twelve-month.}

^{3 EU Regulation 2016/1011 as onshored pursuant to the amended European Union (Withdrawal) Act 2018 and regulations made thereunder.}