JC: Hello and welcome to the latest in our series of Risk Consulting videos which focus on hot topics in the world of risk and regulation.
I’m John Coley, Head of EMEA for our Risk Consulting practice at Norton Rose Fulbright, and I’m joined today by my colleagues April Birring and Iain Hawthorn to talk about LIBOR transition. LIBOR is the benchmark used for in excess of $350 trillion in financial contracts worldwide, meaning this is a truly global issue for businesses across the world. At Norton Rose Fulbright we have a Global LIBOR Transition Team supporting clients across various jurisdictions and this work spans both legal and risk advisory matters. In this video we’ll be focusing on the following three areas from a UK perspective overall:
- Some key LIBOR transition milestones achieved in 2020;
- The recently published International Swaps and Derivatives Association (or ISDA) Protocol and Supplement; and
- A round up of areas businesses should be focussing on for 2021.
As with most things in 2020, the Coronavirus pandemic has had an impact on preparations for LIBOR transition. However, the central assumption that businesses cannot rely on LIBOR being published after the end of 2021 remains and therefore LIBOR transition will be a critical area of focus as we move into the new year.
So firstly turning to April. April, there have been plenty of developments in respect of LIBOR transition this year. What would you say have been particularly important over the past 12 months?
AB: There certainly have been John. In the UK, the Working Group on Sterling Risk-Free Reference Rates (RFRWG), which was set up in 2015 to implement the Financial Stability Board’s recommendation to develop alternative risk-free rates, set a number of milestones for firms in respect of LIBOR transition.
The key milestones set by the RFRWG at the time, were that firms needed to cease issuing LIBOR linked cash products maturing beyond 2021 by end Q3 2020, and also take steps to enable and promote the transition from LIBOR to the use of SONIA throughout this year. However, as the Coronavirus Pandemic progressed, it became clear that firms needed more time to achieve these milestones, so they were delayed in some areas. For example, the requirement on firms to cease issuing new loans referencing sterling LIBOR that mature after 2021 moved from Q3 of this year, to Q1 of 2021.
That said, there have been some key milestones achieved this year including the Loan Market Association publishing wording for replacement screen rate clauses in October and the launch of the ISDA Protocol and Supplement also in that month. These are particularly important recent developments in supporting firms with the transition away from LIBOR.
One final point to mention is that on 30 November, ICE Benchmark Administration, which is the FCA authorised administrator of LIBOR announced it will consult in early December on its intention to cease US Dollar LIBOR. We understand that subject to confirmation following its consultation, one week and two month US Dollar LIBOR settings will cease at the end of 2021 and that the US Dollar LIBOR panel will cease at 30 June 2023.
JC: Thanks, April. So, Iain, April referred to the ISDA Supplement and Protocol as key developments in recent weeks. Are you able to provide an overview of these, when they come into effect and what they will do?
IH: ISDA published the Supplement and Protocol on 23 October and these are important as they will help derivatives market participants with their transition plans.
Taking each in turn:
- The Supplement will amend ISDA’s 2006 standard definitions for interest rate derivatives to incorporate robust fallbacks for trades linked to interbank offered rates such as LIBOR and this will come into effect on 25 January 2021. From this date, all new cleared and non-cleared derivative trades that reference the ISDA standard definitions will automatically incorporate the new fallbacks.
- Turning to the Protocol – this is a contractual amendment mechanism that is used to make standard amendments to ISDA documentation between adhering counterparties. It will enable market participants to incorporate the revisions into their legacy non-cleared derivatives trades with other counterparties that choose to adhere to the Protocol.
A couple of further quick points on the Protocol:
- Adherence is voluntary, but global regulators are encouraging firms to adhere to support the orderly transition away from interbank offered rates;
- Firms that wish to adhere can do so via the ISDA website; and
- Finally, as of yet, there is no current cut-off date for adherence, albeit ISDA has the ability to designate one with 30 calendar days’ notice.
So reaching a decision on whether to adhere is something that firms, unless they have done so already, should be actively considering as a priority in the coming weeks.
JC: Thanks, Iain. April, Iain mentioned that 25 January 2021 is one important milestone for firms in the coming months in respect of LIBOR transition. What other key milestones should firms be aware of and be preparing for in 2021?
AB: In Q1 2021, the RFRWG expects firms to have completed their assessment of all cash contracts maturing post-2021 to identify those that can be actively converted. This should accelerate the active conversion of these products, with an expectation for completion in Q2/Q3 2021. Furthermore, a new milestone has been defined for derivatives markets, with a target to cease new issuance of sterling LIBOR linked non-linear and cross-currency derivatives maturing beyond 2021 by Q2/Q3 2021.
Some practical steps that firms can take to achieve these milestones include assessing their remaining LIBOR exposure and what can be actively converted, communicating clearly with clients to incorporate robust fallbacks resulting in the smooth conversion of products and adhering to the ISDA Protocol as early as possible to ensure a smooth transition in relation to their derivatives products.
More widely, an important consideration for all businesses is how they manage conduct risk. Organisations need to carefully consider client types and needs, and how they communicate to them in a manner that is fair. This includes structuring communications so clients are aware of what is happening and when, setting out risks that they should be aware of, what action they may need to take in response and where they can go to receive advice on these matters. Businesses should have regard to the information needs of their clients as they prepare such communications, e.g. where they may be less sophisticated or potentially more vulnerable and may require communications to be tailored to their level of understanding.
Finally, firms should be aware that the FCA will receive new powers by virtue of amendments to the Benchmarks Regulation (which will be brought in by the Financial Services Bill), enabling a legislative amendment to so called tough legacy contracts which cannot be actively converted to ensure the orderly wind down of LIBOR. Practically, firms should familiarise themselves with the proposed new powers which are detailed on the FCA’s website, and if they wish to do so, provide input on the two consultations which are open for feedback until 18 January 2021.
JC: Thanks, April and Iain some very helpful points to consider as we approach the turn of the year. Some key takeaways are as follows:
- Overall, businesses cannot rely on LIBOR being published after 31 December 2021.
- Active consideration should be given, if not done so already, to signing up to the ISDA Protocol. The FCA has said it will ask tough questions of regulated firms who elect not to adhere.
- Firms should be ready to cease issuing new LIBOR linked loans and derivatives by the 2021 deadlines and should be engaging with their customers, clients and counterparties in advance to manage the transition. As part of this, it is important to ensure conduct risks are properly considered and managed, with processes appropriately tailored to the needs of customers, clients and counterparties, particularly where they may be less sophisticated or more vulnerable.
- Businesses should familiarise themselves with the consultations in respect of the FCA’s proposed new powers under the Financial Services Bill.
Please get in touch with us if you would like to discuss these areas further, and in the meantime thank you for watching and look out for further videos in our series.