LIBOR – the London Interbank Offered Rate – will end in 2021, according to regulator the Financial Conduct Authority (FCA).
As there is no longer enough wholesale lending between institutions, banks have been basing their submissions to LIBOR on judgements rather than actual transactions.
“The underlying market that LIBOR seeks to measure – the market for unsecured wholesale term lending to banks – is no longer sufficiently active,” said Bailey.
“On the basis of what we can currently observe, activity in these markets is limited, and there seems little prospect of these markets becoming substantially more active in the near future.”
“If an active market does not exist, how can even the best run benchmark measure it? Moreover, panel banks feel understandable discomfort about providing submissions based on judgements with so little actual borrowing activity against which to validate those judgements.”
While many panel banks are no longer keen to shoulder the risk of submitting to LIBOR, the FCA has asked them not to pull out of the benchmark until an orderly transition to a new system can be made. It does have the power to compel banks to continue for a limited time but Bailey said it is preferred this isn’t used.
“We could not – and cannot – countenance the market disruption that would be caused by an unexpected and unplanned disappearance of LIBOR,” he said.
In the UK the Risk Free Rate Working Group has selected reformed SONIA (Sterling Overnight Index Average) as its proposed alternative benchmark.
The Bank of England is working to co-ordinate plans for transitioning. Similar work is also under way in the US.
“The transition will be less risky and less expensive if it is planned and orderly rather than unexpected and rushed,” said Bailey.
He added that there has been support from the panel banks for sustaining LIBOR for a four-five year transition. However the process for changing existing contracts or amending the definition of LIBOR to reference an alternative rate will need to be decided.
A spokesman for trade body UK Finance said not many mortgages would be directly affected. Most mortgages track the Bank of England base rate.
“There were only ever a very small number of mortgages that were linked to LIBOR. That will have been reduced further as any time-limited deals come to an end, he said.”
“Lenders will have to agree a new approach in line with the terms and conditions of the contract if there are any mortgages that extend beyond 2021.”