Interest rate reform: the final countdown for LIBOR

Despite the global pandemic, developments in interest rate reform have continued, with the transition away from LIBOR by end-2021 remaining front and centre of the regulatory agenda. Industry-led developments and, in limited instances, potential legislative solutions, together with clear regulatory milestones, will be critical in achieving effective transition in the time remaining.

Transition and fallbacks

ISDA IBOR Fallbacks Supplement and ISDA 2020 IBOR Fallbacks Protocol

In a key step for the introduction of robust fallbacks in derivative contracts, the ISDA IBOR Fallbacks Supplement and ISDA 2020 IBOR Fallbacks Protocol which were launched in October 2020, became effective on 25 January 2021. The Protocol remains open to adherents and these new fallbacks will be crucial in enabling market participants to address the absence of effective fallbacks where an IBOR becomes permanently unavailable. The 2021 ISDA Interest Rate Derivatives Definitions, the successor to the 2006 ISDA Definitions, are expected to be published later in the year and will consolidate the supplements to the 2006 ISDA Definitions, including the ISDA IBOR Fallbacks Supplement. In addition, ISDA is currently considering floating rate options to assist parties in more closely matching conventions developing in the cash products markets on the use of risk-free rates.

ICE LIBOR Consultation on Potential Cessation

ICE Benchmark Administration (IBA) has also taken steps highlighting the potential for imminent cessation of LIBOR. In December 2020, IBA launched a consultation on its proposal to cease publishing:

• euro, sterling, Swiss franc, yen as well as one week and 2 month US$ LIBOR settings at end-2021; and

• the US$ LIBOR overnight and 1, 3, 6 and 12 months settings at end-June 2023.

This consultation has now closed and, subject to assessment of the consultation responses, the FCA has indicated it will move swiftly to make any appropriate cessation, or pre-cessation, announcements. The results of the consultation, together with any regulatory announcements are expected to provide market participants with a more complete timeline for the expected cessation of the various LIBOR settings.

Transition Roadmap

In light of these developments, and the consistent regulatory emphasis on transition, the Working Group on Sterling Risk-Free Reference Rates (Sterling RFR WG) recently updated its transition roadmap. It calls for cessation of new GBP LIBOR-linked loans, bonds, securitisations and linear derivatives (other than those used in risk management of existing positions) by end-Q1 2021 and completion of due diligence of those legacy GBP LIBOR contracts expiring after end-2021 capable of moving to a replacement rate, with conversion by end-Q3 2021. For non-linear derivatives, whilst the target of transition, where possible, remains end Q3-2021, additional time is granted for cessation of initiation of new products targeted for end-Q2 2021. This reflects the additional complexity associated with transitioning these products and the ongoing work of the Sterling RFR WG’s Non-Linear Derivatives Task Force.

For those with cleared derivatives, it will also be important to monitor the approach clearing houses are taking to transition.

Development of fallbacks for EURIBOR

In the eurozone, the focus continues to be on robust contractual fallbacks rather than a wholesale transition away from EURIBOR. Efforts are underway to ensure that robust contractual fallbacks are available for EURIBOR, with the working group on euro risk-free rates (Euro RFRWG) consulting to identify both events that would trigger a EURIBOR fallback, and fallbacks based on €STR. Final recommendations by the Euro RFRWG are expected to be published by end-Q1 2021.

Dealing with “tough legacy”

The Financial Services Bill proposes new powers for the FCA to, where appropriate, manage the orderly winding-down of a critical benchmark to assist those with “tough legacy” contracts, where transition or amendment is not a realistic possibility. The FCA has conducted the first two of its planned consultations on powers expected to be granted to it under the Financial Services Bill. This includes the proposed power for the FCA to impose a change in methodology or inputs for a critical benchmark which is no longer representative, or expected to become non-representative, in certain circumstances. The intention is to allow continued publication of a “synthetic” form of such a benchmark for legacy transactions where appropriate. Further consultations and statements of policy are expected to follow with a consultation on the FCA’s exercise of anticipated powers to prohibit use of a benchmark under these powers planned for Q2 2021. The FCA has indicated that the most heavily used sterling currency-tenor settings are likely to meet the requirements for the exercise of the FCA’s powers in this regard. A further consultation is also expected during the year on any decision to exercise these proposed powers in respect of LIBOR methodology following the outcome of the IBA consultation on its proposal to cease publication of LIBOR.

The Financial Services Bill also proposes new powers for the FCA to prohibit some or all new use of a critical benchmark which is to cease to exist. The FCA has indicated that this power could be relevant for the use of US$ LIBOR in new contracts after end-2021 and a consultation on the exercise of this power is expected in Q2 2021.

Solutions to tough legacy issues are also being sought in other jurisdictions. Amendments to the EU Benchmarks Regulation (BMR), expected to enter into force shortly, will provide for a contractual override in certain circumstances. In the US, the Alternative Reference Rates Committee has proposed NY state legislation which would provide for a mandatory contractual override for certain NY law governed contracts referencing US$ LIBOR. The New York state executive budget includes LIBOR related legislation and a draft federal legislation has been circulated in Congress.

Nonetheless, with these solutions at different stages and with varying approaches, we expect market participants will continue to explore options to reduce reliance on LIBOR where possible, in line with the recommendations from the official sector or national currency working groups, rather than wait for a legislative solution.

Amendments to Article 28(2) requirements under the BMR in the EU

The changes to the BMR will include amendments to the Article 28(2) requirement that supervised entities using a benchmark produce and maintain robust written plans setting out the actions they would take if that benchmark materially changes or ceases. Whilst relevant competent authorities can currently request those plans under the BMR, following amendment, these plans must be provided “without undue delay”. The recitals also refer to random checks by competent authorities on compliance, so supervised entities should take steps to ensure that plans are prepared and up to date.

At this stage, no equivalent amendment is proposed to the BMR as it is onshored in the UK (UK BMR), however the requirement to provide plans upon request remains.

Extension to transitional period for third country benchmarks under the BMR/UK BMR

Helpfully, extensions to the transition period for third country benchmarks have been made in the UK BMR and, in the EU, are included in the package of amendments to the BMR expected to enter into force shortly. These amendments to the BMR include an extension of the transition period until end-2023 (with scope for a further extension) whilst the UK BMR transitional period currently expires end-2022 and the Financial Services Bill provides for a further extension to end-2025.

This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors.