SFE Insight | A final year of sterling LIBOR transition: the importance of borrower understanding

Daniel Cichocki if Director of LIBOR Transition at UK Finance

Notwithstanding the challenging past year navigating the impacts of Covid-19 and Brexit, the industry is in a positive place in preparations for the end of sterling LIBOR (the London Interbank Offered Rate). However, given the once-in-a-lifetime nature of the end of LIBOR unsurprisingly some challenges remain and it is becoming ever more critical that all market participants maintain progress and navigate the risks associated with the move to alternative rates.

For some years now public authorities globally have made clear that LIBOR, a series of benchmark reference rates used for calculating interest rates for financial products, is no longer sustainable and the market should move to safer and more robust alternative rates. On 5 March the Financial Conduct Authority (FCA) confirmed that LIBOR will discontinue across most currencies at the end of 2021, including sterling.

Though undoubtedly a positive move to more robust rates, transition nonetheless requires a significant undertaking for the industry. Here at UK Finance, we are working with around 100 of our members in the UK banking and financial services industry, to not only support them in preparation for this transition, but also help them engage their impacted customers. The industry has of course been working towards the end-2021 deadline for some time and the recent FCA announcement provides renewed certainty that lenders and borrowers have less than eight months  to get ready for the cessation.

The Working Group for Sterling Risk-Free Reference Rates (RFR Working Group), the national working group driving transition, has set out a number of milestones the industry must meet to help facilitate a smooth transition. For example, since the end of Q1 of this year, market participants have no longer been able to issue any new sterling LIBOR linked loans, bonds, securitisations and linear derivatives that will expire after the end of 2021.

Now this significant milestone has been reached, market participants will be aiming to complete active conversion, where viable, of all legacy sterling LIBOR contracts expiring after end 2021 by the end of Q3 of this year. If it is not viable, they will ensure robust fallbacks are adopted where possible. Preparation for these milestones is no small feat, and pressure from authorities to meet them is only growing.

'The end-game for LIBOR is now increasingly clear. Firms should now have everything they need to shift new business to SONIA and to complete their plans for transition of legacy exposures. There is no longer any reason for delay.' - Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA (here).

When implementing their transition programs, lenders will need to keep borrowers front of mind. Not only considering how they will identify, and then amend, contracts that will need to be transitioned, but also the conduct risk associated with moving to an alternative rate, the costs of amendments, the impact on linked products and how to assess customers’ operational readiness.

For the majority of customers in the sterling market, the RFR Working Group has recommended the Sterling Overnight Index Average (SONIA) compounded in arrears as an appropriate replacement rate. However, the Working Group has acknowledged other reference rates including a term SONIA rate or Bank Base Rate, may be appropriate, including for small / mid-corporate customers where simplicity and/or payment certainty may be key.

For this cohort a pivotal consideration for lenders is likely to be conduct risk, and crucial to the mitigation of this is a comprehensive approach to client outreach. Conduct risk has featured high on the FCA’s agenda, and regulators have repeatedly reminded banks to start customer communication activities as early in the transition as possible. More information on the FCA’s conduct expectations during transition can be found in their Conduct Risk during LIBOR Transition Q&A.

Ensuring customers are suitably informed of the costs, risks and benefits of alternative reference rates will enable them to make an informed choice and support the achievement of good customer outcomes. Customers should be sufficiently well informed, and their individual circumstances taken into account during the transition process. However, before all this can effectively happen, business customers need to first be aware of transition, and prepared for these conversations.

As an initial starting point, UK Finance, working with the CBI, ACT, ICAEW and LMA, have developed a simple introductory guide to transition. The Guide is designed to raise awareness amongst borrowers who are not yet familiar with the move away from LIBOR, setting out key recommendations, such as reviewing LIBOR mentions (in both products and accounting systems), assessing the implications different rates could have, and planning on how to transition with minimum impact. It is intended to be useful starting point, building on previous outputs from the RFR Working Group encouraging engagement amongst end user groups and supplementing lender’s individual communications on transition.

LIBOR transition is hugely complex. It’s not just a simple regulatory change but will have an organisation-wide impact on lenders, their clients, counterparties and vendors. Market participants should expect this to include changes to business strategies and client management, impacts on systems and processes, as well as financial accounting, reporting and tax implications. To avoid disruption, all market participants will need to work together to meet the LIBOR transition deadlines. If market participants are still uncertain as to how they should be preparing for the end of sterling LIBOR, securing an understanding of the next steps cannot be put off any longer.

To find out more on how to prepare for LIBOR transition read UK Finance and the Lending Standards Board’s best practice guidance on the transition from LIBOR for SME customers. For a further resource on how small – mid size corporates can prepare, see the parallel UK Finance guide for business customers.

Published 21 May 2021