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FCA allows use of temporary 'synthetic' LIBOR rates

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FCA allows use of temporary 'synthetic' LIBOR rates
These synthetic rates will not be available for use in any new contracts, it said, in a bid to encourage a move away from LIBOR rates as soon as possible. Photo: Chris Helgren/Reuters

The Financial Conduct Authority (FCA) has confirmed that it will use a temporary “synthetic” version of the London Interbank Offered Rate (LIBOR) for existing contracts using sterling and yen when the benchmark interest-rate index is discontinued at the end of the year.

The City watchdog has allowed the use for legacy LIBOR contracts, other than cleared derivatives, that have not been changed at or ahead of 31 December.

These synthetic rates will not be available for use in any new contracts, it said, in a bid to encourage a move away from LIBOR rates as soon as possible.

Following a consultation with financial institutions, the move means that from 1 January 2022, all LIBOR settings excluding 1-, 3- and 6-month sterling and Japanese yen and five US dollar settings will cease.

LIBOR is the benchmark interest rate at which major global banks lend to one another. It is currently based on submissions provided by a panel of banks.

These submissions are mostly based on estimates intended to reflect the interest rate at which banks could borrow money on unsecured terms in wholesale markets.

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Many contracts that use LIBOR have already been switched to new risk-free overnight interest rate benchmarks or will do so at the end of the year.

The FCA first proposed the creation of the synthetic rates in June for temporary use in existing contracts.

“But there is a risk of disruption to markets and consumers if interest payments in LIBOR loans, mortgages, bonds, and other contracts that have not switched by the end of 2021, cannot be calculated,” the FCA said.

As a result, the FCA is requiring the publication of 1-, 3-, and 6-month LIBOR rates for sterling and Japanese yen on a synthetic basis until the end of 2022, to allow more time to complete the transition.

In September, the regulator announced its decision on a fair, transparent and appropriate way of calculating synthetic LIBOR, approximating what LIBOR might have been in the future.

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The FCA has told lenders who are replacing LIBOR with an alternative rate in their contracts, especially those related to mortgages, to treat their customers fairly. They should communicate with borrowers in good time and ensure they are able to consider all options in advance of LIBOR becoming unavailable.

It added that the use of US dollar LIBOR will not be allowed in most new contracts written after 31 December 2021.

Edwin Schooling Latter, director of markets and wholesale policy, said: “Today’s publications form some of the final building blocks in the transition from LIBOR, a global effort led by the FCA and the Bank of England in conjunction with industry and overseas regulators.

“But work should not stop here. While synthetic LIBOR reduces risk in the transition and provides a bridge to Risk-Free Rates like SONIA, it will not last indefinitely and contracts need to be moved away from LIBOR wherever possible.”

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