Libor Administrators to Publish Synthetic Rates in 2022: FCA

The UK’s Financial Conduct Authority (FCA) has confirmed that following the end of the euro, Japanese yen, sterling and Swiss franc Libor panels on 31 December 2021, the benchmark regulator – ICE Benchmarks Administration (IBA) will be required to publish one, three and six-month settings for sterling and yen under a ‘synthetic’ methodology, based on term risk-free rates, for the duration of 2022.

The FCA stresses that the six Libor settings will be available only for use in some legacy contracts, and are not for use in new business. It adds that it expects that five US dollar Libor settings (the above three tenor plus overnight and one-year) will continue to be published based on the current bank panel methodology until mid-2023.

The regulator says the decision has been made to “ensure an orderly wind-down” of Libor, adding the six Libor settings will become “permanently unrepresentative of their underlying markets from 1 January 2022”.

The synthetic rate has been chosen by the FCA to provide a reasonable and fair approximation of what panel bank Libor might have been in the future. The synthetic rates will no longer, however, be ‘representative’ as defined in the Benchmarks Regulation (BMR).

The FCA has confirmed the methodology it will require the administrator to use for calculating the synthetic rates as: forward-looking term versions of the relevant risk-free rate (i.e. the ICE Term Sonia Reference Rates provided by IBA for sterling, and the Tokyo Term Risk Free Rates (Torf) provided by Quick Benchmarks, adjusted to be on a 360 day count basis, for Japanese yen); plus the respective ISDA fixed spread adjustment (that is published for the purpose of ISDA’s Ibor Fallbacks for the six Libor settings).

The FCA further says it will decide and specify before year-end which legacy contracts are permitted to use these synthetic rates. It has published a consultation on its proposed decision, and says that at least for the duration of 2022, it is proposing to permit legacy use of synthetic sterling and Japanese yen Libor in all contracts except cleared derivatives. Clearing houses plan to transition all cleared sterling, Japanese yen, Swiss franc and euro LIBOR contracts to risk-free rates by end-2021.

The consultation closes on 20 October and the FCA says it will confirm its final decision on permitted legacy use as soon as practicable after.

“Market participants have made good progress in actively transitioning contracts in line with the Working Group on Sterling Risk-Free Reference Rates’ recommended end-Q3 target,” the FCA states. “But the proposals today recognise that it will not be practicable to convert all outstanding sterling and Japanese yen Libor contracts by year-end. The FCA and PRA will continue to monitor firms’ efforts to remove any remaining dependencies on Libor across all asset classes, both leading up to and after end-2021.

“Users of Libor should continue to focus on active transition rather than relying on synthetic Libor,” it continues. “Synthetic Libor will not be published indefinitely.”

The regulator says it will also consider progressively restricting continued permission to use synthetic Libor in legacy contracts if this would help maintain progress towards an orderly cessation, and thereby support its objectives to protect consumers or market integrity. This may be necessary if, for example, work to reduce the stock of outstanding legacy Libor contracts does not continue, it says.

“Market participants have made huge progress in moving away from Libor,” says Edwin Schooling Latter, director of markets and wholesale policy at the FCA. “Today’s publications confirm some important details of how Libor will now be brought to an end. New use of sterling, Japanese yen, Swiss franc, euro, and – with only limited exceptions, US dollar – Libor will have to stop at end-2021. The publication of a ‘synthetic’ rate for some sterling and Japanese yen Libor settings for a limited period will give market participants a bit more time to complete transition of legacy contracts. We encourage firms to use that time well.”