Foundations for post-Libor system sliding into place

LONDON: Critical steps for replacing Libor could be taken by next year, British industry officials told Reuters, increasing the chances of a smooth transition from the interest rate benchmark used to price financial contracts worth tens of trillions of pounds.

When regulators announced last month that scandal-plagued Libor would be replaced by the end of 2021, there was scepticism among some industry players over whether such a huge transition could take place on time – or even at all.

But preparations are already underway to put in place two essential elements for the planned replacement, SONIA, to assume its role in the market.

The clearing arm of the London Stock Exchange, which already clears short-dated SONIA swaps – products used to hedge against adverse moves in rates or currencies – told Reuters it was planning to clear the kind of longer-dated swaps covered by Libor.

An industry group, whose members include the 16 top dealers of swaps and other derivatives, meanwhile said it aimed to create SONIA futures contracts.

Francois Jourdain, who chairs the group set up by the Bank of England to promote adoption of SONIA, said he had no doubt that the transition would take place. “It will happen,” he said. “It may be difficult, it may happen on a different time frame depending on different levels of difficulty, but it will happen.” Such moves would be crucial, but even should they come to pass, hurdles would remain to the adoption of SONIA across the British financial industry.

Concerns about the costs associated with changing over – such as in altering IT systems – could deter some companies, particularly those enacting expensive Brexit contingency plans.

Sectors like insurance could also face formidable technical, and potentially legal, hurdles if they were to switch from Libor to assess future liabilities.

Libor – the London Interbank Offered Rate – is a daily rate in a range of currencies which is used to price contracts ranging from home loans and credit cards to derivatives.

It is based on submissions from banks of interest rates they believe they would be charged by others for borrowing money.

Banks have been fined billions of dollars for trying to manipulate the benchmark, prompting regulators to come up with alternatives.

Last month the UK’s Financial Conduct Authority set the end-2021 deadline for switching to the Bank of England’s Sterling Overnight Index Average – SONIA – based on transactions done in the market, rather than Libor-style estimates.

Currently derivatives contracts worth 7.7 trillion pounds are priced against SONIA, but mainly short-term contracts going out 18 months in duration.

This compares with Liborbased contracts worth about 30 trillion pounds going out to 50 years.

While the industry group, whose members include the likes of Barclays, BNP Paribas, Citi, Deutsche Bank and HSBC, have backed SONIA as the alternative for Libor, making the change won’t be easy or quick. — Reuters