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TRANSITION FROM LIBOR TO RISK-FREE RATES
by Katie Kelly and Charlotte Bellamy
Synthetic sterling and yen LIBOR
In June 2021, the FCA published a consultation paper on its proposal to require the administrator of LIBOR, ICE Benchmark Administration, to change the way one month, three month and six month sterling and Japanese yen LIBOR settings are determined after 2021 to secure an orderly wind-down. This would be the first exercise of the FCA’s new powers introduced through amendments to the UK Benchmarks Regulation (UK BMR) under the Financial Services Act 2021. The exercise of these powers will transition the six identified sterling and yen LIBOR settings from their current “waterfall methodology” based on panelbank submissions to an alternative methodology. LIBOR based on this alternative methodology is commonly referred to as “synthetic LIBOR”. ICMA responded to the FCA’s consultation in August noting and elaborating upon the following points. • Following the announcement by the FCA on 5 March 2021 that the six identified sterling and yen LIBOR settings will no longer be representative and representativeness will not be restored immediately after 31 December 2021,
ICMA supports the exercise by the FCA of its powers under
Article 23D(2) in order to introduce “synthetic LIBOR” for the six identified LIBOR settings. • In order for synthetic LIBOR to meet its aim of supporting an orderly wind-down of LIBOR, all parties will need to take the same view as the FCA that “synthetic LIBOR remains LIBOR”. The legislation that HM Treasury is expected to introduce (and has since introduced) in order to support contract continuity further will therefore be very important. • It will also be very important for synthetic LIBOR to be published in the same manner (using the same screens and at the same time) as LIBOR. Following the consultation, the FCA announced that it had published notices confirming its decisions to compel the continued publication of the six identified sterling and Japanese yen LIBOR settings for a limited time period after end-2021 using a “synthetic” methodology. This is intended to help ensure an orderly wind-down. The FCA announcement also confirmed that the FCA will decide and specify before year-end which legacy contracts are permitted to use these synthetic LIBOR rates. This is needed because UK supervised entities will be prohibited from using synthetic LIBOR (within the meaning of the UK BMR), unless the FCA permits some or all legacy use. The FCA published a consultation on its proposed decision, which closes on 20 October.
For further information on the context of these announcements and key issues for the bond market, please see the Quarterly Assessment in this Quarterly Report.
Contact: Charlotte Bellamy charlotte.bellamy@icmagroup.org
The role of Independent Advisers in LIBOR-referencing bonds
In LIBOR-referencing bond documentation, Type 2 fallbacks (for which the trigger events are typically the permanent cessation of LIBOR and certain other events such as a prohibition on use of LIBOR) and Type 3 fallbacks1 (for which the trigger events are typically the same as Type 2 fallbacks but also include an announcement of the non-representativeness of LIBOR by the supervisor of the administrator of LIBOR) often require the appointment by the issuer of an Independent Adviser to make certain determinations.
The role of Independent Adviser is situation-specific with clearly defined responsibilities, as set out in the fallbacks; very broadly, this includes assisting the Issuer in determining (a) the appropriate successor rate or alternative rate, (b) the inclusion of any adjustment spread, and (c) any other required amendments to the documents to reflect the use of the successor rate or alternative rate or the adjustment spread (such as amendments to the definitions of the day count fraction, business day or relevant screen page). The Issuer should appoint the Independent Adviser as soon as possible in advance of the Independent Adviser having to make the relevant determinations for the relevant bond.
It is however important to check the terms and conditions of the relevant bond, as the extent of the Independent Adviser’s involvement varies; in some cases, the Issuer determines the appropriate successor rate or alternative rate, the adjustment spread and any further required amendments, but the Issuer may have an obligation to consult with the Independent Adviser. Typically, the terms and conditions of bonds also provide that if, despite using its reasonable endeavours, the Issuer is unable to appoint an Independent Adviser (or the Independent Adviser is unable to make the relevant determination), the Issuer can determine the appropriate successor rate or alternative rate, adjustment spread and any further required amendments itself. In the absence of such a fallback provision, if the Issuer is unable to appoint an Independent Adviser, it would not be possible to adopt a successor rate or alternative rate without bondholder consent.
Both a successor rate for GBP LIBOR and a credit adjustment spread for use in cash products have been recommended by the Sterling Risk-Free Rate Working Group. As it is generally expected that these successor rate and credit adjustment spread recommendations will be applied to all GBP LIBOR bonds which anticipate their use, this should minimise the associated discretions on the part of an Independent Adviser who would therefore not have to make the relevant determinations.
As a matter of practice, in advance of making its formal determinations as described above, the Independent Adviser should consult with the Calculation Agent, the Principal Paying Agent or any other party responsible for determining the rate of interest to ensure that the proposed methodology and timings are workable in practice and accepted, as they will be the parties required to make the necessary calculations and payments. Once the determinations have been formally made, the Issuer is required to notify them to these parties promptly or within a sufficient time frame to enable the Calculation Agent to update its systems in order to carry out the new calculation (and for the clearing systems’ records to be updated). According to ICMSA Bulletin 210510/56 on The role of Calculation Agents and Benchmark Agents/Independent Advisers, the Independent Adviser is “typically required to be an independent financial institution of international repute or an independent financial adviser with appropriate expertise in the international debt capital markets”. In addition, the ICMSA Bulletin states that “It is not expected that either the Calculation Agent or Principal Paying Agent would take on such role”. This is because the Calculation Agent and Principal Paying Agent have been employed by the issuer to discharge a particular function which is purely mechanical in nature and non-discretionary. The role of Independent Adviser is an additional function that would not have been within the original remit, or foreseen in the relevant bond documentation, although the overall institution which performs the Calculation Agent and Principal Paying Agent roles may have a separate function enabling it to serve as an Independent Adviser. It is therefore important that issuers familiarise themselves with the precise language contained in their documentation in advance of the possible triggering of these fallbacks in LIBOR bonds before the end of 2021 and consider whether the input of an Independent Adviser is required.
Contact: Katie Kelly katie.kelly@icmagroup.org
Developments in SARON
At the meeting of the National Working Group (NWG) on Swiss Franc Reference Rates on 1 July 2021, the NWG recommended start dates for using only SARON as a single price reference and benchmark in derivative markets. It recommended that all market participants (investors and issuers) switch to the SARON swap curve as the only pricing reference starting from 1 September 2021 at the latest, and that only SARON-based derivatives should be used for new transactions starting from 1 July 2021 (excluding transactions that reduce or hedge LIBOR exposures). The ICMA Swiss Syndicate Managers Group, which comprises the heads and senior members of the syndicate desks of member firms active in lead-managing syndicated bond issues in Switzerland, agreed at its meeting on 13 July 2021 to disseminate an announcement that, starting from 1 September 2021, Swiss franc new issues will be priced referencing the SARON Mid-Swap Rate (Bloomberg Ticker: SFSNT). This was followed-up by a subsequent announcement on 20 August, which also stated that to support the transition, syndicate banks will continue to publish the spread vs LIBOR Mid-Swap on a purely indicative and nonbinding basis until 31 December 2021. Elsewhere, the Swiss Financial Market Supervisory Authority (FINMA) has provided additional clarification relating to derivative trading obligations where adjustments are made solely to address LIBOR replacement or are justified by the corresponding reference rate reform. FINMA also called on the market participants to continue their preparations for the LIBOR replacement as a matter of the highest priority.
