The path to a post-Libor City: Bank of England takes control of substitute benchmark
The City will today take its next step on the path to a post-Libor future as the Bank of England unveils reforms to the Sonia “risk-free” reference rate, although experts have warned of potential headaches ahead.
The Bank of England will take over the running of Sonia, the Sterling Overnight Index Average, from tomorrow, with the rate based on actual transactions rather than expert judgement in a bid to make it much less open to abuse.
The Libors, the London Interbank Offered Rates, act as “risk-free” benchmarks for contracts in six major currencies with an estimated notional value of $350 trillion, making the rates a key cog in the global financial system.
Read more: It’s official: The BoE will start setting Libor replacement Sonia in April
However, Libor’s name has also become synonymous with scandal after the high-profile convictions of multiple ex-bankers for rate-rigging their submissions to a panel which set the rates.
Deepak Sitlani, a partner at law firm Linklaters, said the huge volume of affected transactions had prompted “nervousness in the market”, but that the new start for Sonia would spur increased liquidity in the derivatives companies use to hedge their contracts.
Senior bankers working on the transition have told City A.M. that creating a bigger market in Sonia products will be crucial in moving the industry away from Libor.
Read more: FCA boss urges industry to solve “big unanswered question” on Libor
However, long, “legacy” contracts remain a sticky issue, with the possibility loans or derivatives tied to Libor could lose their benchmark rates, potentially causing chaos.
Andrew Bailey, the head of the Financial Conduct Authority, announced last summer that the City watchdog would no longer force banks to continue to submit Libor rates from 2021 onwards. Some of the big banks on the panel whose submissions help to determine Libor had tried to leave to avoid further legal risk, but faced pressure to remain from regulators who feared the crucial – if sullied – benchmark would collapse, City A.M. understands.
The US Federal Reserve last month unveiled its Libor replacement for dollar transactions called Sofr, the Secured Overnight Financing Rate, while the European Central Bank and counterparts in Switzerland and Japan are also planning their own alternative for their respective currencies.
Read more: Financial watchdog says banks will back Libor until 2021
The Sonia launch will add further pressure to Intercontinental Exchange (Ice), which took over the administration of Libor in 2014 following the scandal and has since made significant changes to its methodology in a bid to make it less subjective.
Yet without the backing of the regulator, some industry participants have expressed concerns that Libor’s days may be numbered, shutting down a revenue stream for the US financial infrastructure giant.
However, Greg Campbell, a financial regulatory partner at law firm Gibson Dunn, said market demand for Libor to continue underpinning long legacy contracts will ensure its survival.
“None of them have any mechanism if Libor simply disappears,” he said. For new contracts, “I haven’t seen any move in financial contracts (such as swaps) away from Libor.”
“Libor will evolve,” he added, with a likelihood of further moves towards an index-like approach.
Ice declined to comment.
Read more: Intercontinental Exchange ups stake in Euroclear