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Regulators creating interest rate uncertainty – a Treating Customers Fairly issue?

by: Tony Ward, chairman of Landbay and Fellow of the Association of Corporate Treasurers
  • 28/04/2021
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Regulators creating interest rate uncertainty – a Treating Customers Fairly issue?
Although it may seem such a long while ago, particularly given the events of the last year, we are still feeling the impacts of the global financial crisis and regulatory attempts to clean up past misdeeds.


One of these is the London Interbank Offered Rate (Libor) scandal of 2008 when it became evident that individuals in the market had been rigging and price fixing Libor for gain. Since that time Libor has had its cards marked and by the end of 2021 it will have been phased out for sterling transactions.

Libor is the rate at which prime banks lend to other prime banks for a set period of time. So you can have overnight Libor, one-week Libor, three-months Libor, and so on. It has been a flexible pricing mechanism that can cater for bespoke pricing and periods. And, because it is for a period looking forward, the rate reflects the market expectations for rates in the future.

This rate has existed since the 1970s and since 1986 was adopted and overseen (not strictly enough as it happens) by the British Bankers’ Association.


The issue

So what went wrong? After growing unease, on 27 July 2012, the Financial Times published an article by a former trader which stated that Libor manipulation had been common since at least 1991. In late September 2012, Barclays was fined £290m because of its attempts to manipulate the rate, and other banks were under investigation for having acted similarly. The British Bankers’ Association said on 25 September 2012 that it would transfer oversight of Libor to UK regulators. And this is what happened. Job done you might think?

Sadly, no: The decision was made to phase out Libor and this is what we are trying to implement right now.


What next?

The chosen successor rate is the Sterling Overnight Index Average (Sonia). This is set daily and is a single-day rate. So, if I’m a corporate setting my interest rate for the next three months, I won’t know what the interest rate was until the end of the period. Effectively, Sonia would be calculated for every day in the period and averaged for the period. Hardly helpful when trying to plan and hedge.

Sonia is not the same as Libor at all. One is a rate looking forward for period of time and takes into account expectation of interest rates during that period and the other is simply the daily average of rates during that period. Not the same thing at all.


The mortgage angle

But now we come to mortgages: there are a number of mortgages where interest rates are set relative to three-month Libor and lenders need to re-price these loans and communicate this clearly to borrowers.

Some lenders will be looking at their mortgage conditions and finding that there will be no legal option to change the rate without customer consent. So, what to set the rate to? And how best to advise the borrower in a clear and transparent way? Not easy.

It seems to me that what we have done is create a massive opportunity for consultants and advisers who are now advising the mortgage community how to square the circle between Sonia, Libor and Bank Rate. They will be analysing significant amounts of historic data to find core relationships between these rates that they can justify to themselves and to borrowers.

As a Fellow of the Association of Corporate Treasurers and a market practitioner of many years standing I can tell you it just can’t be done. We are comparing fundamentally different rates. And because lenders have been tasked to get on with it without guidance from Treasury or the regulator we are likely to see lenders arriving at different rates aimed at achieving the same thing. Confusing!

It would have been helpful if Treasury had foreseen this; it could have then declared a standard new system. For example, where Libor ceases for consumer priced loans, that Base Rate, either with or without a basis point adjustment, could be substituted instead. This would have saved a lot of unnecessary cost and confusion.

It will be interesting to see how a lender will be able to share data to justify any substitute rate with its borrowers, in a way that makes sense, when lenders are having difficulty enough understanding it themselves.

Maybe what we need is a true substitute of Libor, which Sonia clearly isn’t. How about synthetic Libor?

Unwittingly perhaps, but the regulators have created a confusing situation for borrowers and are at risk of breaking one of their core principles – not treating customers fairly.


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