On 21 February 2019, Megan Butler, the FCA’s Executive Director of Supervision: Investment, Wholesale and Specialists delivered a speech on firms’ ongoing transition from the use of the London Interbank Offered Rate (“LIBOR“) to overnight risk-free rates (“RFRs“).
Butler highlighted the importance of firms managing down their LIBOR-linked derivatives books and moving portfolios across to swaps based on the Sterling Overnight Index Average (“SONIA“), describing LIBOR as an “anachronism” and noting that the markets for which it was originally built had changed beyond recognition.
She warned firms to plan for a future in the absence of LIBOR stating that the FCA would not shift on its plan to discontinue LIBOR at the end of 2021.
In 2018 the FCA and the PRA had written to large banks and insurers seeking assurance that these firms were preparing for the transition to alternative reference rates (“RFRs“). Having received feedback from this exercise, Butler took the opportunity to share some of the FCA’s early observations. She acknowledged that sell-side firms were in different states of readiness for the LIBOR transition, but noted that nearly all of the firms the FCA wrote to have now identified the Senior Mangers responsible for implementing their transition programmes. Butler reminded firms of their responsibility to prepare for the transition, commenting that:
“Billions of dollars-worth of financial contracts needs to move on to a new benchmark rate. If this transition is chaotic, it could have serious repercussions. It is therefore an imperative that we take preparations for 2021 seriously.”
Butler acknowledged that the profile of the transition was lower on the buy-side noting that “the scale of the challenge is high”. The FCA’s main message to these firms was “do not make the back book problem worse than it needs to be” but to actively start transitioning now in order to minimise disruption. In the derivatives market, she observed that many of the reasons used for delaying moves to alternative RFRs (for example, waiting for liquidity to develop, waiting for new term rates to be produced based on the new overnight RFRs, or citing dealing costs acting as a deterrent to transition) were now less relevant in today’s market.
Butler encouraged asset managers to carry out due diligence and identify LIBOR exposures; weigh up the costs of transitioning portfolios against the impact of a potentially costly re-papering exercises in the future; and to transition hedges and positions over to SONIA before LIBOR disappears and before liquidity in LIBOR-derivatives begins to decline. The FCA has not prescribed one approach to achieve this, only that it must be done.