Libor Deadline Extension Would Be ‘Huge Relief’ for Markets
Banks in the U.K. and Japan appear to have won critical breathing space just three months before the London interbank offered rate is retired in those markets.
U.K. regulators announced plans on Wednesday for the rate’s administrator to keep publishing an artificial Libor number through 2022. Firms in the sterling and yen markets could be allowed to continue using that rate in all legacy contracts except cleared derivatives, the Financial Conduct Authority said.
That’s an unexpectedly generous move. According to Marcus Morton, managing director at consultancy Duff & Phelps, it could ease the transition for assets including business and consumer loans, bonds, securitizations and swaptions.
The proposals “are likely to be a huge relief for market participants everywhere,” said Andrew Gray, a partner at PricewaterhouseCoopers. “There are hundreds, if not thousands, of Libor-referencing contracts, which are in practical terms impossible to transition before the year-end.”
The U.S. earlier this year took its own steps to release pressure by extending key dollar Libor tenors for 18 months until mid-2023. The Federal Reserve previously told firms to stop using dollar Libor in new contracts by year end. The FCA said Wednesday that it could allow limited use beyond then for circumstances including market making and hedging.
If the FCA proposal goes ahead, the U.K. and Japanese markets will be able to rely on “synthetic Libor,” created without using trading data from banks.
“It is a plan for legacy products which was sorely needed,” said Priya Misra, global head of interest rate strategy at TD Securities in New York and a member of the Alternative Reference Rates Committee, the Fed-backed body guiding the transition.
The announcement marks a concession to limited preparation in some corners of the market and is also broader than many expected, according to Shankar Mukherjee, U.K. Ibor leader at EY. JPMorgan Chase & Co. had previously raised concern it wouldn’t be clear which contracts would be protected by synthetic Libor until at least October.
Libor is deeply embedded in financial markets. Around $200 trillion of derivatives are tied to the U.S. dollar benchmark alone and most major global banks will spend more than $100 million this year preparing for the switch.
Claude Brown, a partner at law firm Reed Smith, said the restrictions on new dollar Libor use were “quite tight” and that the exemptions looked logical. However, the implied ban on loans linked to the benchmark could prove challenging, especially given slow progress toward replacement rates in the U.S. And while the FCA plays a leading role on the global transition, there may be questions about where its rules apply.
“The practical difficulty will be if you’re a U.K.-regulated lender and your borrower says: Why don’t we use dollar Libor in our new loan,” Brown said. “The lending bank will have to say they can’t do that. That’s going to cause a bit of friction.”
Regulators have been phasing out the rate for more than four years and there are concerns the concession could deprive the transition of momentum.
Allowing synthetic Libor for another year “arguably defers the problem,” said Michael Cavers, a partner with the law firm CMS.
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