UK regulators force banks to speed up efforts to scrap Libor

UK regulators have stepped up efforts to ensure the banks are making headway with their plans to ditch the scandal-tainted Libor and switch to an alternative interest rate benchmark.

They have written to bank heads demanding to see their assessment of risks relating to scrapping Libor as well as the specific steps they would take to lower those risks.

Bank chief executives have until December 14 to provide details on their firms’ plans to move away from the London interbank offered rate, often described as the world’s most important number.

UK's Prudential Regulation Authority and Financial Conduct Authority also asked executives to identify one or more senior managers who will oversee the transition away from Libor at their firms.

“The purpose of the letter is to seek assurance that firms’ senior managers and boards understand the risks associated with this transition,” the UK agencies said in a joint statement.

The letters are expected to be the start of numerous requests from the FCA, PRA and other regulators as the 2021 deadline draws near.

Global regulators have warned banks to get ready for the end of the Libor - a rate that underpins US$240 trillion of financial products globally - and switch to “risk free” rates.

They have, for the past four years, been trying to scrap Libor since, not only has the rate been subject to manipulation, but it is not anchored in active, liquid underlying markets.

“Some financial firms, however, have been reluctant to imagine a world without Libor and worry about the uncertainty of scrapping it,” says Oliver Wyman, the global risk specialist.

Still on the books

The big problem is that after Libor is gone, there will still be lots of products on the books of banks and insurance companies that still depend on it.

Contracts often include fallback provisions specifying contract terms in case Libor is unavailable.

“If the period of unavailability is brief, say due to a technical glitch, as was expected when the contracts were drafted, the resulting losses and gains will be manageable,” said Serge Gwynne, an Oliver Wyman partner.

What's worse, if fallback terms are used for the remaining life of the contract, the economic impact is likely to be significant, creating winners and losers.

“Under every Libor rock there is another rock. “Libor is pervasive, and the regulators want to know that the banks really understand the risks, added Gwynne.

UK regulators have already rolled out a new risk-free rate called Sonia while their US counterparts in April launched the Secured Overnight Funding Rate, or SOFR.  

While they look to be the best option, neither of them will mirror Libor, hence the concern - and now clearly the regulators - about who will wear the cost.

“The UK regulators have asked the question but US chief executives should expect the same,” said Gwynne.

“Firms that are continuing to sell products based on Libor face real conduct risk, but there are often no viable alternatives because the replacement rates are not mature yet,” he added.

“It’s time firms speed through the five stages of LIBOR grief and into acceptance.

“The urgency to mobilise is only increasing.”

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