Interest Rate Benchmark Reform

In response to well documented cases of manipulation and false reporting of interest rate benchmarks, together with the decline in liquidity in interbank unsecured funding markets, the G20 asked the Financial Stability Board (FSB) to review critical benchmark rates, including GBP LIBOR, and develop plans for their reform.

In July 2014 the FSB published its report ‘Reforming Major Interest Benchmarks’, recommending that risk-free reference rates (RFRs) should be created as an alternative to LIBOR, the Bank of England has just announced the launch of a Working Group on Sterling Risk-Free Reference Rates.

In the UK, the Financial Conduct Authority is overseeing the reform of Libor (including sterling Libor) and the Bank of England is overseeing the development of sterling RFRs. The intention is that the working group will recommend a sterling RFR by June 2015, and begin implementation by January 2016.

In order to ensure that benchmarks remain robust and are appropriately used by market participants, the FSB recommended a “multi-rate approach” with two broad objectives:

  • Strengthen existing benchmarks and other potential reference rates based on unsecured bank funding costs (including sterling Libor) by underpinning them to the greatest extent possible with transaction data.
  • Develop alternative, nearly risk-free, reference rates. Certain financial transactions, including many derivative transactions, are better suited to rates that are closer to risk-free. Developing such alternative reference rates meets the principle of encouraging market choice.

Chris Salmon, Executive Director of Markets at the Bank, addressed the first Working Group meeting stating that: “…change will not happen spontaneously – liquidity in long-dated swaps is firmly concentrated in contracts referencing LIBOR and no individual player can change that situation. What is required is a collective effort to change market practice.”

The Working Group on Sterling Risk-Free Reference was initiated to assist the Bank of England in meeting its objective of developing sterling RFRs. It is a private sector group comprised of senior experts from major sterling swap dealers. Salomon explained why the initiative is market led: “We believe that this needs to be a market-driven process and that the choice of RFR is yours to make. However, this is not an academic exercise. A “choice” means that you will be prepared to make meaningful transition commitments over a 12 to 24 month horizon.”

The key deliverables tasked of the group are to:

  • Identify best practices for alternative sterling nearly RFRs
  • Identify best practices for contract robustness
  • Propose reforms for existing sterling nearly RFRs
  • Develop an adoption plan
  • Create a transition plan with metrics of success and a timeline

The Working Group is expected to engage in outreach to a wide range of stakeholder groups, including central counterparties, exchanges, benchmark administrators and end‐users (e.g. institutional investors, government‐linked institutions, and corporate treasurers). The Bank of England will facilitate this outreach process by hosting roundtable meetings at the request of the Working Group. The indicative timeline is:

  • March 2015: Organisational meeting of the Working Group and election of Chair
  • April 2015: Working Group delivers detailed work plan and agrees schedule of future meetings
  • June 2015: Working Group recommends sterling RFR
  • July 2015: Working Group agrees plan to make contracts more robust
  • December 2015: Working Group delivers plan to promote adoption of RFR amongst a broad cross-section of market participants, including end users
  • December 2015: Working Group agrees a transition plan to implement the RFR as an alternative to LIBOR
  • January 2016: Implementation begins

The speech by Chris Salmon is available here.

The Working Group web site is available here.

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