LIBOR to lose FCA backing from 2021
- Published: Friday 28 July, 2017
- Category: BTL mortgages
- By: Andrew Pelis
- Updated: Friday 04 August, 2017
From 2021, the LIBOR (London Interbank Offered Rate) benchmark lending rate will no longer receive backing from the UK’s leading financial regulator the Financial Conduct Authority (FCA).
Andrew Bailey, head of the FCA confirmed the move, citing the need for the financial industry to move to a more reliable marker.
Bailey confirmed that banks had agreed "voluntarily to sustain LIBOR for a four- to five-year period, i.e., until end-2021."
Whilst the rate may continue to be used by banks beyond then, if it does continue, it will "no longer be sustained through the mechanism of the FCA persuading or obliging panel banks to stay," he emphasized.
At present, there is uncertainty regarding the impact on legacy contracts that use the LIBOR rate, should the benchmark cease to exist.
The LIBOR is referenced in £268 trillion of contracts worldwide
The Bank of England has indicated that the LIBOR is currently referenced in £268 trillion of contracts worldwide, including in corporate lending, mortgages and even student debt.
Governor of the Bank of England, Mark Carney, said earlier this month that he wished to create “near risk-free rates” a desire echoed by his colleague Chris Salmon, executive director for markets, who stated that he wanted to move to a “less LIBOR-centric world.”
LIBOR, a tarnished reputation
The LIBOR’s reputation suffered following the financial crisis, when it was discovered that the banks involved in setting the rate were found to have manipulated it to gain profit. Consequently, banks were forced to pay billions of pounds of fines and a number of bankers were sent to jail.
Formerly administered by the British Bankers’ Association, the LIBOR was passed to the independent Intercontinental Exchange (ICE) in 2014 and Bailey stressed that the FCA had no evidence of any more issues concerning the setting of the rate.
More pertinently, he suggested that a lack of market liquidity around unsecured wholesale term lending between the financial institutions, had resulted in the LIBOR struggling to accurately reflect market conditions.
One of the aims of the reform process has been to try to anchor LIBOR submissions and rates to the greatest extent possible to actual transactions.
This June the FCA launched an exercise to gather market data from 49 banks to determine the most active "actual and potential" participants in unsecured wholesale bank borrowing and related markets. Whilst this work is not yet complete, data indicates that activity in these markets is limited, and there seems little prospect of them becoming substantially more active in the near future.
The FCA considers that it is not only potentially unsustainable, but also undesirable, for market participants to rely indefinitely on reference rates that do not have active underlying markets to support them. Furthermore, it does not believe that it is appropriate to ask, or to require, panel banks to continue to submit expert judgements indefinitely; all of which contributed to the statement made by Bailey.
Transitioning away from the LIBOR
The FCA will look to oversee a smooth transition over the coming years, aiming for a "planned and orderly" transition away from LIBOR.
This is essential as a means to reducing the risks from financial markets' current dependence on LIBOR. However, this work is unlikely to begin in earnest if market participants continue to assume that LIBOR will last indefinitely.
The FCA has had extensive discussions in recent months with the panel banks that currently both sustain and rely on LIBOR, as well as central banks and regulatory authorities in other jurisdictions about the length of time required for an orderly transition away from the current widespread use of LIBOR. The consensus is that it will be challenging, but could probably be achieved within four or five years.
Consequently, the FCA has spoken with the panel banks about them voluntarily agreeing to sustain LIBOR until the end of 2021. The intention being that, at the end of this period, it would no longer be necessary for the FCA, through its influence or legal powers, “to persuade, or compel, banks to submit to LIBOR”.
All of this leaves questions concerning what will happen to LIBOR after the end of 2021, and to legacy contracts that still reference LIBOR at that date. In relation to the latter question, it will be necessary to consider whether the better approach to transition would be to amend contracts to reference an alternative rate, or amend the definition of LIBOR through the fall-back protocol to replace the current methodology with alternative reference rates.
With four years to put in place a suitable replacement, a risk-free reference rate produced by the Bank of England, known as Sonia, the Sterling Overnight Index Average, is a current front-runner.
What does the move away from LIBOR mean for landlords?
Jorden Abbs, head of operations at Commercial Trust, discusses what this news means for UK landlords,
“If you do not have any LIBOR tracker rate buy-to-let mortgages this news will not directly affect you.
If you do have a buy-to-let mortgage that tracks the LIBOR, there is no need to panic. As outlined above, the LIBOR will be phased-out gradually over a four-five year period.
There is a possibility that your initial rate period may end in advance of the LIBOR being phased out completely, in which case your advisor here will research a suitable alternative product to switch to.
As decisions are made as to which rate will replace the LIBOR and lenders start to plan for and implement the transition away from it, things will become clearer.
A rudimentary consequence may simply be that we all become familiar with a new rate that tracker products follow which could mean a new swathe of products replacing the LIBOR products before them.”
We will be following the evolution of the transition away from the LIBOR and, as ever, our chief executive Andrew Turner will be keeping those subscribed to his newsletter updates abreast of the changes.
This information should not be interpreted as financial advice. Mortgage and loan rates are subject to change.