Zombie LIBOR birthday official
Ahead of LIBOR’s end of year demise, market participants have been waiting for clarification from the FCA on what “tough legacy” actually constitutes, i.e. those contracts which may continue to reference synthetic LIBOR.
Following yesterday’s publication of a series of documents, it turns out that “tough” might be better expressed as “slightly irksome”. Para 4.28 of the draft Notice of Permitted Legacy Use by Supervised Entities confirms that the six synthetic GBP and JPY LIBOR settings will be available to all OTC legacy contracts. The FCA recognise that there is a relatively small group of transactions which are truly inimical to RFR fallback/amendment,
“However, we think it would be disproportionate for us at this point to undertake the complex task of attempting to delineate this group of contracts from the remainder in a manner that provides sufficient clarity and confidence for derivatives users. This would be complex and we have assessed that it would take a considerable amount of time, expertise and research for such a delineation to be both accurate and clear…Therefore, we think that permitting continued legacy use by all uncleared derivatives is the best way to provide clarity and certainty for the market in a timely manner.”
While paying lip service to the notion that “only uncleared legacy derivatives that are structurally or explicitly linked to other uses of the Article 23A LIBOR Versions need to be permitted to continue to use them following prohibition”, the draft Notice clarifies that all applicable uncleared derivative contracts which have not already been amended via the Protocol or bilaterally will be able to reference synthetic LIBOR. Synthetic LIBOR is likely to have a limited shelf-life, publication of GBP synthetic rates will be reviewed at end-2022, after which JPY synthetic LIBOR is expected to cease.
Regulatory deadlines proving to be more fluid than advertised is to be cynically expected, if certainly not counted on. While regulators should be congratulated on their pragmatism and consequent accommodation to the challenges that market participants face, it is hard to think of a deadline that has been so insisted on as finally final. Identification of “tough legacy” contracts is complex, however it is impossible without guidance as to what “tough” constitutes. LBOR’s tough legacy has proved to be too tough for the FCA.
Other LIBOR news
In other LIBOR news, the FCA provided further clarification on exceptions to the 1 January 2022 prohibition on new trades for the continuing USD LIBOR tenors:
- Market makers may accumulate further exposure to USD LIBOR as a result of client activities seeking to hedge or reduce their exposure to USD LIBOR under contracts entered into before 1 January 2022.
- The FCA clarified that when making use of the exceptions to the prohibition on new trades referencing USD LIBOR tenors, dealers do not have to validate that their clients’ trades conform to the relevant exceptions. They must make all reasonable efforts to ensure that the client is aware of the prohibition and to engage with them regarding to which extent they have accounted for the prohibition.
- The FCA extended the exception regarding the use of interpolation to also allow ‘other use’ of the continuing tenors pursuant to contractual fallbacks.
The widespread adoption of the Fallback Protocol has largely mitigated systemic risk in respect of OTC LIBOR transition, the FCA “extension” is a recognition of the vast hinterland. We can’t speak for FCA, but it is hard to imagine that this is their ideal scenario. This extension should be regarded as last drinks in the LIBOR saloon rather than a resource downgrade.
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