The FCA has published a consultation paper (CP22/11) on the current timetable for the orderly cessation of the 1-, 3- and 6-month synthetic sterling LIBOR settings and whether to establish synthetic US dollar LIBOR settings after the US dollar LIBOR panel submissions end in June 2023.
The consultation period ends on 24 August 2022 and so there is just over a week left for interested parties to submit their responses. The FCA has indicated that it is keen to hear from individual firms.
What are the main points of the FCA consultation paper?
The FCA’ s consultation paper seeks views as to:
- whether the 1- and 6-month synthetic sterling LIBOR settings can cease in an orderly fashion at the end of March 2023 – this offers a short extension from the previous cessation date expected at end of December 2022;
- when market participants believe the most-used sterling setting, 3-month synthetic sterling LIBOR, can cease in an orderly fashion; and
- whether the remaining exposures to US dollar LIBOR settings can be wound down or transitioned to alternative reference rates in an orderly fashion by 30 June 2023, when the submissions to the US dollar LIBOR panel end and, if not, whether synthetic US dollar LIBOR settings might be appropriate for certain contracts that are not within the scope of LIBOR-related US federal legislation.
The consultation paper is clear that the synthetic yen LIBOR settings currently being published will cease as planned at the end of 2022 and there is no expectation that this timetable will change
In the consultation paper, the FCA considers each of the following products that continue to reference the synthetic sterling LIBOR settings: derivatives, bonds, securitisations, syndicated loans, bilateral loans, funds, and mortgages and consumer lending, setting out its current view on the status of the transition of each of these products away from using LIBOR settings.
Broadly, the FCA view seems to be that the market for most of these products should have had adequate time to implement an orderly transition away from sterling LIBOR by the end of March 2023, if not earlier.
Bonds and securitisations
The FCA believes that consent solicitations are an effective route to transitioning any LIBOR-linked bonds (including securitisations) and does not see any "insurmountable barriers" to issuers undertaking, and investors participating in, consent solicitation exercises. Indeed, on 16 August the FCA issued a statement strongly encouraging issuers and bondholders of outstanding LIBOR-linked bonds to take the necessary action to transition outstanding LIBOR-linked bonds. The FCA urges relevant issuers to schedule consent solicitations and bondholders to engage with issuers and request that conversion process are initiated.
Although the FCA acknowledges that there are additional complexities with some securitisations that can impact on timing, such as securing the approval of changes from rating agencies as well as consent from noteholders of tranches that are not linked to LIBOR and therefore not directly affected by the changes, the FCA is of the view that the transition of retained and privately placed securitisations should be more straightforward given that usually there are very few noteholders and there are established relationships between the originator and investors.
Uncleared derivatives linked to cash products
The consultation paper acknowledges that uncleared derivatives that are structurally or explicitly linked to cash products and have not already been transitioned will generally need to remain matched to the cashflows in the underlying cash products. That said, the FCA sees these products as making up a very small percentage of OTC derivatives trades overall and does "not consider that the impact on these contracts when the relevant sterling LIBOR setting ceases would create any additional adverse effect on consumers or market integrity".
The FCA clearly states that it is not aware of any barriers that would prevent the orderly transition of syndicated loans away from sterling LIBOR by the end of March 2023. The FCA notes that it has been informed of the additional time involved for PFI loans that require local authority consent, but warns that it takes the view that the additional time provided by allowing synthetic sterling LIBOR settings to be used until March 2023 should have been sufficient to allow these consents to have been obtained and so there should be no need for any further extension or forbearance.
In relation to defaulted or distressed syndicated loans that will not be capable of transition away from LIBOR, the FCA anticipates that lenders will have written off the losses on these loans already and therefore does not expect that a failure to transition these products will cause any material additional disruption when the sterling LIBOR settings cease.
The FCA acknowledges that mortgage products referencing sterling LIBOR (in particular 3-month sterling LIBOR) may present the biggest challenge because they require consent from the borrowers, who may not be engaged with the LIBOR transition process in the same way as other parties in the market. Notwithstanding this, the FCA expects lenders of mortgage products using 1-month synthetic sterling LIBOR to be capable of transitioning by the end of March 2023. For the larger volume of mortgage products that still reference 3-month synthetic sterling LIBOR, the FCA implicitly acknowledges that completing the transition for these by March 2023 may not be possible, but expects lenders to prioritise efforts to implement this transition and requests relevant parties to provide their transition plans and timetables for these products when responding to the consultation.
No extension of panel bank US dollar LIBOR settings beyond the end of June 2023
The consultation paper clearly states that there will be no extension to the end date of 30 June 2023 for panel bank US dollar LIBOR settings. The FCA's view is that the additional 18 months of availability for US dollar LIBOR settings calculated using panel submissions has provided market participants with considerable extra time to transition away to suitable replacement rates and allowed more legacy contracts to reach maturity.
The FCA has generally applied the same reasoning as it applied for the various product categories in the context of sterling LIBOR. In relation to mortgages and consumer lending, the FCA notes that most mortgages and consumer lending that reference US dollar LIBOR will be governed by the law of a US jurisdiction and therefore are not part of the scope of the FCA's consultation.
Will there be a synthetic US dollar LIBOR?
The FCA is, however, seeking views on whether the temporary publication of synthetic US dollar LIBOR settings is necessary after 30 June 2023 to ensure the market has sufficient time for an orderly transition away from US dollar LIBOR.
As products governed by US law will generally benefit from the US federal Adjustable Interest Rate (LIBOR) Act of 2021 that provides for US law-governed contracts to transition automatically to alternative rates at the end of June 2023 (or are out of scope as they contain robust fallbacks), the FCA considers that contracts governed by US law should not be the cause of a disorderly cessation of US dollar LIBOR. Accordingly, the FCA's focus is solely on US dollar LIBOR contracts not governed by US law.
In determining whether to compel the publication of synthetic US dollar LIBOR settings following the panel cessation in June 2023, the FCA will consider the evidence submitted during the consultation about any products for which it would be difficult to complete an orderly transition away from US dollar LIBOR by that date. The consultation paper confirms that any synthetic US dollar LIBOR methodology would follow a similar approach to the methodology for synthetic sterling LIBOR and synthetic yen LIBOR. In any event, the FCA emphasises that market participants should not rely on any synthetic US dollar LIBOR rates being available after 30 June 2023 and that, if published, any synthetic US dollar LIBOR would only be available for a temporary period.
Responses to the consultation
In its statement issued on 16 August, the FCA strongly encourages market participants who will be affected by the cessation of any remaining sterling LIBOR settings to respond to this consultation as it is keen to hear the views of impacted stakeholders both in the UK and more globally. However, the FCA is quite clear that it expects affected market participants to continue with their transition efforts and that it "will not compel the administrator of LIBOR to continue to publish LIBOR rates for the convenience of those who could take action to convert their contracts, but have not done so.".
In its response to this consultation paper, the International Capital Markets Association ("ICMA") argues that the FCA needs to be clear beyond doubt that there are no significant risks of market disruption and that that it "would be very difficult for the FCA to be clear beyond doubt this year in the case of the 3-month setting, and much better to be prudent by conducting another review next year. The risks in the bond market are likely to be lower in the case of the 1-month and 6-month settings, as there are fewer legacy bonds referencing those settings.".
In relation to US dollar LIBOR, ICMA argues that it will be important that synthetic US dollar LIBOR is published from 30 June 2023 in order to reduce the risk of a disorderly wind-down in the international bond market as there are a high number of legacy US dollar LIBOR bonds governed by English law with insufficient fallbacks which will be challenging to transition before the end of June 2023. In addition, any synthetic US dollar LIBOR rate should be as close as possible to the rate expected under the US federal legislation (term SOFR plus a spread) so as to minimise any market disruption.
The FCA will no doubt consider carefully the responses and evidence received to its consultation paper, which will inform its final decisions in respect of the end dates for the various synthetic sterling LIBOR settings and the need for synthetic US dollar LIBOR after the end of June 2023.
If you rely on synthetic sterling LIBOR or US dollar LIBOR settings for products for which it would be difficult to transition away before the FCA's proposed cessation dates of 31 March 2023 or 30 June 2023, respectively, it is important that you respond to the FCA consultation by the closing date of 24 August 2022. The FCA strongly encourages market participants from outside the UK to respond, given the widespread use of US dollar LIBOR globally. Responses can be provided in writing to the address provided in the consultation paper, using the online form on the FCA website or by email.
Based on the outcome of the consultation and the responses provided, the FCA will consider the position with respect to the continued publication of the 1-, 3- and 6-month synthetic sterling LIBOR settings and notify the market later this year (with the short extension for 1- and 6-month tenors likely confirmed to end of March 2023 from the end of December 2022). The FCA will also assess, in due course, whether it should require publication of US dollar LIBOR on a synthetic basis when the US dollar LIBOR bank panel ends in June 2023
Please get in touch with the team at Hogan Lovells if you require any further information or support in relation to transition of any remaining products.
This note is for guidance only and should not be relied on as legal advice in relation to a particular transaction or situation. Please contact your normal contact at Hogan Lovells if you require assistance or advice in connection with any of the above.
Authored by Jennifer O'Connell, James Doyle, Isobel Wright, and Nicholas Watmough.