Moving On: The FCA and Bank of England encourage banks to let go of LIBOR
June 25, 2019
2 min read
What's going on here?
Two years after Andrew Baily, head of the FCA (Libor’s regulator), effectively stated that LIBOR would be gone by 2021, the FCA and the Bank of England (BoE) recently encouraged banks to move to the new benchmark SONIA.
What does this mean?
What is LIBOR?
LIBOR (London Interbank Offered Rate) is the average interest rate (set by banks) at which global banks agree to borrow from one another.
The rate is calculated everyday by the Intercontinental Exchange (ICE) by asking big global banks what their rates would be for a short-term loan to another bank. LIBOR is the basis for consumer loans as well as interbank products and so determines the ease of borrowing between banks and consumers as the rate fluctuates.
What is SONIA?
SONIA (Sterling Overnight Interbank Average Rate) is an overnight rate, used for off-hour trades, that is calculated by the BoE. SONIA was created in 1997 but was reformed last year as part of the effort to replace LIBOR. Following the LIBOR rate rigging scandal that was revealed in 2012, the FCA realised that they needed rates that were calculated by more reliable institutions such as the BoE in order for the rates to be credible. Britain is leading the way with regards to replacing LIBOR, but the US, the eurozone and Switzerland are also working fast to replace LIBOR with alternative benchmark rates.
LIBOR will be phased out by 2021 but hitting that deadline with a smooth transition will not be an easy task considering that $240 trillion of loans, bonds and derivatives are set according to LIBOR rates.
What's the big picture effect?
SONIA is slowly becoming widely used in the derivatives and bond markets, with numerous markets and contracts now using the rate instead of LIBOR. But progress is slower than the FCA would have hoped for. It is clear that banks do not yet consider LIBOR as a soon-to-be-extinct rate, despite the 2021 deadline for phasing out LIBOR. With such a clear and fast-approaching expiration date having been underlined by Andrew Baily and the FCA why is the transition so slow?
Currently, SONIA is not cited as the “fallback” rate in a post-LIBOR era on most contracts. This leaves many market participants with doubts about what will replace LIBOR. SONIA also means that any borrower will not know exactly what their interest will be until the end of the loan’s term, as it is calculated as a backward-looking average. Again, this is a drastic change for borrowers who usually know rates in advance.
However, SONIA has its benefits. It will allow London to be ahead of other financial centres and boast a more innovative new infrastructure. The FCA wants CEOs to spend more time and money on preparing for the transition and establishing clear governance on the matter.
But will businesses hit the ambitious deadlines that regulators have set?
Report written by Will H
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