Partner Abdulali Jiwaji and Head of Knowledge and Legal Services Johnny Shearman examine the global issue of the cessation of Libor, in The Banker.
Abdul and Johnny’s article was published in The Banker, 8 April 2021, and can be found here.
The cessation of the London interbank offered rate (LIBOR) is a global issue but there is a disjointed approach to tackling the problems caused by this event. If not vigilant, market participants may find themselves financially exposed as a result.
Despite LIBOR’s global reach, it is the UK Financial Conduct Authority (FCA) that is ultimately responsible for bringing about the demise of LIBOR around the world. In July 2017, Andrew Bailey, then CEO of the FCA, announced that after 2021, the FCA would no longer expect panel banks to submit rates required to calculate LIBOR, in anticipation of transitioning to an alternative system. At the time, the FCA’s announcement was largely welcomed and had been anticipated, in the wake of the findings of widespread collusion between major banks aimed at manipulating LIBOR for profit.
LIBOR transition is not just about shifting new business away from LIBOR-linked products. It also requires the conversion of outstanding, or legacy, contracts which reference LIBOR and would be impacted after the 2021 cessation date. Arguably, both challenges are inextricably linked – without a viable alternative for new business it is near impossible to tackle legacy issues. The issues become compounded when one takes account of the fact that LIBOR exists in five currencies and seven borrowing periods and is used in calculating floating or adjustable interest rates for numerous financial products.
However, despite the global challenge, the FCA and the UK’s other regulatory bodies are naturally focused on the transition of products away from sterling-linked LIBOR, leaving overseas jurisdictions to tackle the transition away from LIBOR products linked to other currencies and operating under different governing laws. Regulators in other jurisdictions, therefore, also find themselves in the position of needing to effect change to end the reliance on LIBOR-linked products. The result is that LIBOR transition is being handled differently around the world.
To date, one of the most significant areas of divergence stems from the Intercontinental Exchange’s Benchmark Administration’s (IBA) announcement late last year that it will delay, until June 2023, ceasing to publish the most widely used tenors of US dollar LIBOR. Effectively this means financial products linked to US dollar LIBOR will be sustained beyond the end of this year creating, effectively, a two-tier transition. Whilst some have questioned the IBA’s intention, many have welcomed the idea. There was already mounting criticism by many market participants using US dollar LIBOR that the Secured Overnight Financing Rate (SOFR), the proposed US dollar-linked risk-free rate, is inadequate in light of sudden fluctuations that have been observed. Further time is needed therefore to enable business to transition away from US dollar-linked LIBOR products.
Legacy contracts and, in particular, tough legacy contracts (which are those that do not have robust fallback provisions and cannot be converted to a risk-free rate) are another area of divergence.
In the UK, the FCA will be given powers to impose a change in LIBOR’s methodology if it is no longer representative, to allow a synthetic LIBOR-based methodology to be deployed for tough legacy contracts up until maturity. By contrast, the New York based Alternative Reference Rates Committee (ARRC), is bringing about a legislative proposal to address legacy contracts that are linked to US dollar LIBOR and governed by New York law. In principle, the ARRC’s legislative fix will mean that any contracts that do not contain an appropriate fallback provision will automatically transition from LIBOR to SOFR, the recommended substitute to LIBOR. However, given that SOFR is facing criticism, New York’s proposal may stumble out of the gates if dissent among market participants continues, resulting in other LIBOR alternatives, such as the American Interbank Offering Rate, being used.
In Europe, the European Commission proposes to amend existing EU regulation to accommodate the cessation of LIBOR. In effect, the European Commission’s proposal will enable it to designate a replacement benchmark that covers all references to LIBOR when it is necessary to do so to avoid disruption of the financial markets in the EU. The statutory replacement rate will be available only for contracts that reference LIBOR at the time it ceases to be published.
The problem that arises with these varied approaches is that any inconsistencies will lead to uncertainty, meaning a greater risk of litigation and potential for regulatory arbitrage. For example, it remains unclear how the UK’s proposal for a synthetic LIBOR for tough legacy contracts will interact with the EU’s proposal to specify a statutory alternative rate. Going forward, therefore, market participants must be alert not only to a changing landscape when it comes to LIBOR but also a diverging, and potentially conflicting, one across different jurisdictions.
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