Banks must stop issuing cash products linked to sterling Libor by the end of September this year and firms must speed up efforts to prepare for the benchmark interest rate's expected end in 2021, Britain's main financial regulators have said.
In a letter to financial firms the Bank of England and the Financial Conduct Authority followed up their deadline with a warning that the BoE's Financial Policy Committee "will keep the potential use of supervisory tools under review in light of transition progress made by firms. As they have made clear, 'The intention is that sterling Libor will cease to exist after the end of 2021. No firm should plan otherwise.'"
This suggests senior managers and banks could face penalties if they fail to act.
Switch to Sonia
Libor was at the center of a scandal which led to traders being jailed and banks fined about $10 billion after they attempted to rig the rate, which underpins trillions of dollars of financial contracts from swaps to loans to mortgages.
The BoE and the FCA also said finance firms should switch the convention for sterling interest rate swaps from Libor to the newer, risk-free rate Sonia by March 2. This is aimed at encouraging financial firms in the derivatives market to move away from Libor, the central bank said.
Sonia, the sterling overnight index average, is the BoE's preferred alternative to Libor.
"Sonia has now become the norm in new issuance of floating rate sterling bonds and securitizations, and it is encouraging to see the successful transition of Libor-referencing securities to Sonia," said Edwin Schooling-Latter, director of markets and wholesale policy at the FCA.
"But there is still much more to do. We encourage market participants to build upon this momentum."
The regulators also want firms to establish a framework for the transition of legacy Libor products to significantly reduce the stock of Libor referencing contracts by the first quarter of 2021.
Finance firms should also consider how best to address issues surrounding "tough legacy" contracts — those Libor-based contracts which cannot easily be switched to a risk-free rate or do not have fallback clauses allowing such changes to take place.
Along with the recommendations from the regulators, the industry working group, chaired by Tushar Morzaria — who is also Barclays' group finance director — published guidance on bond contracts which reference sterling Libor and are due to mature beyond the end of 2021.
This said such so-called "legacy bonds" needed to be switched to Sonia-based reference rates and the most orderly way to do that would be to replace or amend legacy bond contracts that reference Libor before fallback provisions are triggered.
It said this can be done with the consent of bondholders and that, so far, eight consent solicitations with a total nominal value of £4.2 billion have been announced publicly as successful in moving English law legacy bond contracts from Libor to Sonia.
"With the adoption of Sonia well underway, attention now must turn to the orderly transition of legacy transactions from Libor to Sonia," Morzaria said. "The success of the transitions already undertaken, together with the release of the considerations, indicate that the relevant tools are available, and it is now up to all market participants to use them."
The regulators have also sent a joint letter to major banks and insurers setting out their expectations of firms' transition away from Libor during 2020.
Regulators want Libor, or the London interbank offered rate, to stop being used by financial firms by 2021, though there remains considerable confusion over when it will no longer be regarded as "representative" by regulators.
Libor is set by a panel of banks based on the average interest rate at which they can borrow from each other, together with the panel's expert judgement. Its appeal to the market is that it offers forward-looking term rates, unlike regulators' preferred alternatives of risk-free rates, which are based on the cost of overnight borrowing. But risk-free rates like Sonia, compounded in arrears, are regarded as a reasonable alternative to Libor's forward-looking capacity by regulators.
Morzaria's group said the use of Sonia compounded in arrears as an alternative to Libor is appropriate and operationally achievable for 90% of new loans by value.
"2020 will be a pivotal year in the transition journey, with critical focus on enabling the flow of new business away from sterling Libor," said Morzaria.
Some markets, like derivatives and fixed income have begun to move away from Libor, but lending and securitization markets still make extensive use of it.