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Sept 19 – Who is Sonia

Lenders are currently heavily involved in making plans for the abolition of LIBOR, however this may come as a bit of a surprise to intermediaries.  The lack of public utterances so far masks a vast raft of work going on in the background.  For many they will replace this with SONIA as the alternative market rate.  The FCA believes that all firms need to plan for the cessation of LIBOR, which is scheduled for 2021.  Little however is known about how this will be engineered, communicated and completed, with many existing products bridging the transition date.

Within banks and lenders, exposure to LIBOR is not only deep embedded across firms’ assets and liability structures, but also in a wide range of computer applications and used for valuation, pricing, performance evaluation and risk management.  The FCA has been reviewing preparedness and is suggesting that it is prudent for firms to undertake a thorough review to identify where and how LIBOR is relevant to their business and if they also have exposure to other interbank offered rates (IBORs).

For brokers they will want to look at which lenders are still using LIBOR in their product offerings and have discussions on what their plans are on a number of fronts.  Where they have products that run past the transition date, how do they propose to replace LIBOR related products and what will be their communication plan with both brokers and customers?  There are concerns that replacement rates could be more volatile or more expensive.

Many responses to the joint PRA/FCA Dear CEO letter flagged the need for market consensus and regulatory intervention as key dependencies inhibiting transition plans.  Some firms have therefore apparently adopted a ‘wait and see approach’.  The FCA has acknowledged the dependencies but used their statement to urge firms to consider how they engage with the various initiatives to deliver a consensus and also their individual contingency plans if solutions do not materialise.

Whilst many responses showed that firms were proactively beginning to transact using alternative rates, a number of responses placed considerable reliance on market solutions to overcome barriers whilst not being clear how they themselves were working to provide a solution e.g. SONIA linked loans.

Feedback from the enquiries by our regulators has indicated that most firms had to extract their exposure information manually, requiring significant effort and highlighting risks in the robustness of their numbers due to the manual nature of the exercise.  Whilst some responses from firms indicated significant understanding of the exposure a number failed to.

Most firms identified a UK Board level senior manager to oversee the progress of their project, ensuring co-ordination across the different stakeholders and that sufficient resource was made available to support the firm’s transition activities.  The strongest responses set out the reporting lines and relevant management information received providing effective oversight for the project.

Firms are focused to avoid a ‘cliff edge’ in 2021 and some have already taken opportunities to transfer exposures to new RFRs (Risk free rates) prior to 2021.  The regulator is concerned that in some responses there was no consideration or a lack of understanding of conduct risks e.g. market manipulation, conflicts of interest and mis-information or disadvantage to clients.

Overall it appears that some firms are well advanced and proactively managing the transition from LIBOR and others are not.  The FCA does not say what its own actions are as a result of the information that it now holds.  Whilst the FCA has not focussed on intermediary firms and their actions, there is a risk that not making proper enquiry of lenders and failure to flag with customers that LIBOR based products will be subject to change could be an increasing risk.

Robert Sinclair
September 2019


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