knowledge | 8 March 2021 |
LIBOR: FCA Announces Future Cessation and Loss of Representativeness
The Financial Conduct Authority (“FCA”) has announced the future cessation or loss of representativeness of all LIBOR benchmarks. This underscores the importance of transitioning from LIBOR before the end of 2021 and also, importantly, will constitute a pre-cessation trigger for many financial contracts.
Key Points in the FCA Announcement
After 31 December 2021, publication of:
- all LIBOR settings for euro and Swiss franc; and
- the majority of LIBOR settings for the remaining currencies (Japanese yen, sterling and US dollar),
will permanently cease.
After 30 June 2023, publication of overnight and 12-month US dollar LIBOR settings will cease.
The FCA will consult on using proposed new powers to require publication on a synthetic basis of 1, 3 and 6 month sterling and yen LIBOR settings for a further period, in the case of sterling, and for one additional year, in the case of Japanese yen, beyond 31 December 2021. Importantly, the FCA announcement confirms that such publications would “…no longer be representative of the underlying market and economic reality…” after 31 December 2021. It also noted that it will continue to consider the case for requiring publication of 1, 3 and 6 month US dollar LIBOR on a synthetic basis for a further period beyond 30 June 2023, again on the basis that it would no longer be representative of the underlying market and economic reality from that date.
Fallbacks: Pre-Cessation Triggers
The FCA announcement also expressly confirms:
“We make this statement in the awareness that it will engage certain contractual triggers for the calculation and future application of fallbacks that are activated by pre-cessation or cessation announcements made by the FCA (howsoever described) in contracts, and in accordance with our 11 March 2020 statement on LIBOR contractual triggers”.
That confirmation has important implications for LIBOR-referencing contracts with pre-cessation fallback triggers.
Derivatives: in response to the FCA announcement, ISDA has published guidance (see here) outlining its impact on fall-back provisions for derivative contracts that incorporate either:
- the ISDA IBOR Fallbacks Supplement and Protocol (for further information on which, see our earlier briefing here); or
- the ISDA 2018 Benchmarks Supplement.
The key message in that guidance is that the FCA announcement constitutes an “index cessation event”, triggering the fixing of fallback spread adjustments for the purposes of transitioning to the relevant successor rates under the IBOR Fallbacks Supplement and Protocol at the point of the announcement.
This spread adjustment is a key component of any applicable fallback rate and is designed to address an important structural difference between interbank offered rates (“IBORs”) and the risk free rates (“RFRs”) used as a basis for the fallback rates; RFRs are overnight rates without any credit component, whereas IBORs have a credit-sensitive term structure. The fallback provided by the IBOR Fallbacks Supplement and Protocol for each IBOR setting is based on the relevant RFR compounded in arrears to address differences in tenor plus a spread adjustment (to account for credit risk and other distinguishing factors between IBORs and RFRs) and is calculated using a historical median approach over a five-year lookback period from the date of an announcement on cessation or non-representativeness.
That spread has now been fixed, as at the date of the FCA announcement, for all LIBOR currency tenors (see here). This provides greater clarity regarding the fallback rate that will apply to arrangements encompassing the IBOR Fallbacks Supplement, or encompassed by the related Protocol, once cessation or non-representativeness actually occurs1, assuming that those arrangements have not been actively transitioned to an alternative rate in the meantime.
Loans: since the planned discontinuation of LIBOR was announced, loan agreements (especially in the syndicated markets) have increasingly included mechanisms that would assist with a transition to a relevant successor rate. Loan agreements that provide for a “switch” mechanism and/or for the replacement of “screen rates” (such as LIBOR) are likely to require some action in relation to LIBOR transition, on foot of the FCA announcement.
Bonds: LIBOR fallback/transition provisions in bond programmes may also have been triggered by the FCA announcement, given the inclusion of “pre-cessation triggers” in some more recent fallback provisions.
While not unanticipated, the FCA announcement about the cessation of LIBOR and the triggering of pre-cessation provisions in LIBOR-referencing contracts is a significant event. Parties to such contracts should ensure that they are fully aware of the impact of the FCA announcement on their rights and obligations under those contracts and that, where necessary, they engage with their counterparties.
- It should be noted that, given how the fallbacks provided for by the ISDA Fallbacks Supplement and Protocol operate (providing first for linear interpolation between relevant surviving IBOR tenors, if any), whereas publication of the 1 week and 2 month US dollar LIBOR settings will permanently cease after 31 December 2021, the calculation agent will from then until end-June 2023 (when the remaining US dollar LIBOR tenors cease or become non-representative) calculate the rate using linear interpolation between the next shorter and next longer US dollar tenors that continue to be published. It should also be noted that the application of fallbacks for US dollar LIBOR will impact on calculation of the Singapore dollar Swap Offer Rate and the Thai Baht Interest Rate Fixing, as US dollar LIBOR is a component in the calculation of those rates.
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.