The consultation, which began on Wednesday 18th November and runs until 18th January 2021, contains no surprises for FinBrief readers, but there are a few pointers. As readers know, the onshored BMR will be amended by the Financial Services Bill to empower the FCA to approve a so-called “synthetic LIBOR” for use even after it has ceased to be representative of the underlying economic reality it purports to represent. The central provisions are new Articles 23A-23D to be inserted into the UK-onshored Benchmark Regulation, and synthetic LIBOR will be classified as an “Article 23A benchmark”. The FCA’s powers under 23D(2) “are not limited by the market or economic reality that was intended to be measured by the benchmark immediately before it became an Article 23A benchmark”. Synthetic LIBOR is intended for the tough legacy – “contracts that genuinely have no or inappropriate alternatives and no realistic ability to be renegotiated or amended” (although one suspects that the eventual legal regulation will simply permit its use only for contracts entered into before a specific date and not materially amended since then). Where contracts can feasibly be converted by agreement (e.g. through ISDA’s protocol mechanism for derivative contracts, or through consent solicitations for bonds) they should be: these are not part of the tough legacy, and market participants “should continue to progress their transition efforts and plans and to meet their regulatory obligations, particularly through active conversion or the insertion of robust and workable fallbacks”. A synthetic methodology would not restore the “representativeness” of LIBOR, but would be designed to provide “a reasonable approximation of”, and would “in essence be economically equivalent to”, the “expected value of the overnight RFR compounded in arrears over the relevant period or term”. The FCA will seek market input on the synthetic methodology but for GBP LIBOR it will inevitably place great weight on the OIS swap market (i.e. fixed vs compounded in arrears SONIA interest swaps).
It seems clear that there will be no synthetic LIBOR for CHF or Euro. The challenge is USD LIBOR, where a synthetic rate is needed, but the equivalent of the OIS market (i.e. a market for fixed vs compounded in arrears SOFR) is very small in comparison (it was reported in 2019 that US trade repository data had the gross notional amount of the SONIA swaps market in the year to May 2019 at USD 2.8 trillion, whereas SOFR was way behind on USD 90.3 billion), so either that needs to get a lot more liquid first, or else an alternative will have to be looked for. At this point, the FCA gives us no hints about the possible outcome merely stating:
“We cannot say now whether there will be an appropriate and feasible change of methodology for all LIBOR currencies, but will set out in future statements of policy our thinking on where methodology change could be feasible and appropriate”.
It explains that “the LIBOR rate (including the screen rates) would be preserved and remain in place for tough legacy contracts” so, once all this is done, we can expect it to be published on screen page LIBOR01, so that “tough legacy” contractual references to LIBOR continue to work. Timing-wise, the FCA envisages extensive engagement with the market over the coming months, which dovetails with developments being lagged so that the non-tough legacy will move away from LIBOR onto an RFR first, in order to minimise the use to which synthetic LIBOR will be put.