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The Bank of England has a message for financial businesses exiting the scandal-plagued Libor benchmark: Get moving.
It issued a statement on Thursday giving banks until September to cease issuing cash products linked to sterling-denominated Libor, a benchmark which underpins $30 trillion of financial contracts in sterling markets alone. The direction is part of a wider effort to speed up transition in the derivatives market before the benchmark expires at the end of 2021.
“There is a lot to be done,” said Simon Woods, a partner at Ernst & Young LLP. “Firms not being ready gives rise to commercial and regulatory risks, and we expect some banks may need to re-prioritize their change programs to hit many of the upcoming deadlines.”
The BOE in 2017 started the countdown on retiring Libor, used for $300 trillion of contracts globally including bonds and loans. For decades the rate served as a benchmark set daily by banks to determine interest rates on everything from student loans and mortgages to derivatives and credit cards. But ever since European and U.S. banks were found to have manipulated rates to benefit their own portfolios, the benchmark has been seen as tainted.
Markets focused on loans, securitization and treasury products are generally less prepared than those dealing with bonds and derivatives, according to Claude Brown, a partner at Reed Smith LLP in London.
“U.S. banks also seem to be ahead of the curve, possibly because they have had more bandwidth because they have been less preoccupied by Brexit,” he said.
Market makers will be encouraged by the BOE to shift pound-denominated interest-rate swaps on March 2 from Libor to its replacement, the Sterling Overnight Index Average. Businesses should establish a framework for the transition, the BOE said. There’s a $12 trillion backlog of legacy loans that need conversion.
“It is unlikely Libor-linked swaps stop trading completely until all other products have transitioned to Sonia-underlying,” said Antoine Bouvet, a senior rates strategist at ING Groep NV in London. “There is an amount of inertia.” That comes with the U.K. market in what he called “an enviable place” compared to other jurisdictions.
What Bloomberg Intelligence Says
“The clock is ticking louder for the switch to Sonia from Libor. Expect transition flows to continue but trading in Libor-linked products needs to fall significantly to signal the market is ready for the end of Libor. It probably means lower volatility in times of stress given the removal of the credit component.”
— Tanvir Sandhu, Chief Global Derivatives Strategist
The BOE views Sonia as a better measure of general interest-rate levels than Libor because it does not include a term bank credit-risk component. The market for Sonia derivatives is already well established, the BOE said in a joint statement with the Financial Conduct Authority.
The average for cleared over-the-counter Sonia swaps exceeded 4.5 trillion pound ($5.9 trillion) per month over the past six months, and the traded monthly notional value is now broadly equivalent to Sterling Libor.
“The time to act is now,” the BOE said in a statement. “This is a critical year for Libor transition.”
(Updates with comments from EY, Reed Smith.)
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