Global markets regulators are beginning to consider concessions to help banks struggling to shift away from the Libor lending benchmark.
Banks have complained for months that abandoning the discredited Libor benchmark by 2022, as regulators have demanded, will leave them with intractable problems with old contracts and the need to hedge risks. Many fear litigation and disruption.
But a Bank of England working group meeting on Tuesday is expected to allow banks to develop new rates to more closely match their sterling funding and lending costs, according to three people involved in the discussions. Several companies have expressed an interest in administering these rates, two of those people said.
The potential move echoes what market participants say is now a more collaborative approach to the issue in the US.
One of those people said there had been a “big change in tone” from authorities on both sides of the Altantic in recent months. “There’s been a subtle shift from the authorities towards thinking about how they can solve problems and induce the use of new benchmarks.”
The BoE accepts that a transition will involve multiple different rates in different markets, several people familiar with the matter said. But the formation of a rate that encompasses a reflection of banks’ credit risk, as Libor does, may prove to be still out of reach. Many market participants say such a rate is under consideration, but the BoE said it is not involved in any specific discussions along those lines.
Until now, UK regulators have been steadfast in insisting that banks remove any reference to Libor across loans, bonds, mortgages and derivatives, replacing them with other benchmarks such as, in the UK, the overnight lending rate known as Sonia.
Watchdogs in the US, UK, Switzerland, Japan and the European Union want the market to move to these so-called “risk free” overnight rates, which are anchored in transactions rather than traders’ subjective submissions.
In the UK, a new market for Sonia-linked debt has started to develop, but bankers and lawyers say the new rate does not provide a close enough match to manage their longer-term liabilities and assets. That could create severe dislocations in stressed markets.
In spite of the urging from authorities, Libor still provides the reference for pricing about $400tn worth of derivatives, loans and securities contracts. The new rates cover only about 3 per cent of the market, according to data from Isda, the trade body.
The BoE’s working group will consider whether the benchmarks should be “backward-looking” — with previous rates compounded to work out counterparties’ likely future payments. The working group will also consider a benchmark that calculates payments for the life of the contract in advance, as Libor does.
Last week Moody’s, the credit rating agency, warned that efforts to address the transition from Libor had yet to eliminate risks in new transactions, particularly for markets like structured finance and covered bonds.
Moody’s pointed out that benchmark transitions will often carry so-called “basis risk”, with the potential for incoming and outgoing cash flows to diverge. New benchmarks may differ even when based on the same alternative indices, it added.
The flexible approach from the BoE comes after the International Accounting Standards Board also proposed offering relief on the treatment of old Libor-type benchmarks and newer ones, such as Sofr, the US benchmark, as a way to help banks and others take on the task of transition.
IBA, the administrator of Libor, has proposed an index sensitive to bank credit that could serve as an alternative to Libor. However, David Bowman, adviser to the US Federal Reserve, said it was not clear how the rate would behave in times of market stress, and the rate would probably be less accurate than Libor.
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