Financial firms are building up dangerous levels of derivatives linked to the controversial Libor benchmark rate, the Bank of England has warned.
The central bank's financial policy committee said firms are accumulating large amounts of derivatives linked to London Interbank Offered Rate for periods well after 2021, when use of the rate is set to end. Libor was discredited following a scandal in 2012 where traders were found to be fixing their banks' submissions to the rate-setters.
The FPC expects that the continued increase of the outstanding stock of contracts maturing after 2021 based on Libor will go hand-in-hand with medium-term financial stability risks, which can be reduced only through a significant and lasting move away from reliance on Libor, according to a record of the committee's June 19 meeting.
The committee also highlighted that ongoing efforts to develop and implement stronger fallback clauses in existing contracts will also be critical in limiting the risks.
The Working Group on Sterling Risk-Free Reference Rates is set to consult on the development of a potential forward-looking term benchmark rate based on the Sterling Overnight Index Average, or Sonia, while The International Swaps and Derivatives Association is preparing to consult a fallback rate that is expected to replace Libor in derivatives documentation should Libor cease to be available.