In its latest LIBOR transition Consultation Paper the FCA proposes to permit legacy use of synthetic LIBOR in all contracts (except cleared derivatives) until at least 31 December 2022 without conditionality or limitations.

This Consultation Paper coincides with the FCA's decision to compel the publication of 6 LIBOR settings using a synthetic methodology for a limited (but the maximum initial permissible) period of one year. The FCA can require the publication of synthetic sterling LIBOR for up to ten years, with review at least annually.

The FCA has confirmed that the methodology for these synthetic rates will be the forward-looking term versions of the relevant RFR (term SONIA for sterling) plus the respective ISDA fixed spread adjustment, as we discussed in relation to the FCA's earlier consultation on this issue here.

Commentary

With the pressure of the 31 December LIBOR cessation deadline mounting, the FCA proposals give the impression that the LIBOR can is unavoidably being kicked down the road. The time limit might be useful to contracts which can in theory be amended but which need some additional time to do so, for example where a large number of contracts need to transition at the same time, but there are some types of contracts where a time-limited form of synthetic use is unlikely to enable the agreements to be amended.

Consumer mortgages are one key contract type falling into this latter category. The FCA acknowledges that there is a significant retail consumer exposure to 3 month sterling LIBOR; many of the 200,000-plus mortgages in the UK referencing this benchmark either do not contain contractual fallbacks or other variation mechanisms, or do but firms may not be able to rely on them, and mortgage borrowers who are unfamiliar with LIBOR and the fairness of substitute rates, are less likely to engage or agree changes with their mortgage lender. These factors coupled with the estimate that 56% of the regulated mortgages have a maturity of more than 10 years indicate that a solution running beyond 31 December 2022 will be required for consumer mortgages at least.

Next steps

The breathing space afforded by the proposals will be welcome by many market participants but the FCA remains on message; LIBOR users are encouraged to continue their transitioning efforts rather than relying on synthetic LIBOR (the settings are permanently unrepresentative of the market they are intended to measure), and should not assume that synthetic LIBOR will be published indefinitely. And if transition slows or stalls after 31 December as parties rely on synthetic LIBOR the FCA might progressively restrict permission to use synthetic LIBOR in order to maintain progress post-cessation.

Firms intending to rely on synthetic LIBOR need to consider the impact of doing so in the context of their contracts, and communicate clearly with their customers on the effects of referencing synthetic LIBOR. Synthetic LIBOR is, however, a temporary bridge and parties should, wherever possible, continue to focus on active transition.

The consultation period ends on 20 October, and the FCA will confirm its final decision as soon as practicable after that. However, given the proposed breadth of, and absence of conditionality around, permitted uses of synthetic LIBOR any objections to the proposals are likely to be few and far between.

Contributors

Lindsay Lee

Senior Associate

Bruce Stephen

Head of Banking and Financial Services & Partner