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On 17 November 2022, the House of Lords is scheduled to debate the following question for short debate:

Lord James of Blackheath (Conservative) to ask His Majesty’s Government what steps they will take to ensure that the LIBOR system remains available to be exercised by the Bank of England in the event that inter-bank lending is at risk of collapse.

1. What is LIBOR?

The London Interbank Offered Rate (LIBOR) has historically been one of the main interest rate benchmarks used in financial markets, determining interest rates for financial contracts around the world. For example, it was estimated that, as of August 2020, approximately US$400tn of financial contracts globally referenced LIBOR.

LIBOR is based on banks submitting daily estimates of interest rates at which they are willing to lend to one another, with a “panel bank” methodology used to calculate an average rate. It is intended to provide a benchmark set of interest rates representative of the rates at which large internationally active banks access the wholesale, unsecured funding market across different currencies and over different lending periods.

2. The transition away from LIBOR

Issues with LIBOR date back to 2009, when international financial regulators began investigating some financial institutions for alleged misconduct relating to it, including manipulation of the rates. Financial institutions were fined billions of dollars and individuals criminally convicted for LIBOR related offences.

Furthermore, since the global financial crisis in 2008­­–09, activity in the interbank markets—from which LIBOR rates were derived—has declined in light of new regulations encouraging banks to use other forms of borrowing. The Financial Stability Board—an international body that monitors and makes recommendations about the global financial system—stated that the reduced volume of transactions in the markets meant that LIBOR presented a “potentially serious” source of systemic risk to the global financial system and was no longer sustainable in its existing form.

In 2015, market participants formed a working group to support and advise on the transition away from LIBOR.

In 2017, the group recommended an alternative rate for sterling markets, the sterling overnight index average (SONIA). From 2018, the financial regulators—the Bank of England, the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority—alongside the working group, have been encouraging market participants to plan for the transition from LIBOR to SONIA. In March 2021, the FCA set out its expectation that production of the majority of LIBOR rates would end immediately after 31 December 2021 and the remainder by 1 July 2023.

The government warned, however, that there would be “significant barriers to moving off LIBOR”, including the issue of ‘tough legacy contracts’—contracts unable to be converted to a non-LIBOR interest rate before the end of 2021. It said that without further action parties to tough legacy contracts could be left with no means of determining payments under them, an issue which the Bank of England has said presents a financial stability risk.

As a result, the government legislated to provide statutory support for the transition away from LIBOR, including through the Financial Services Act 2021 and the Critical Benchmarks (References and Administrators’ Liability) Act 2021. A key objective of these reforms was to provide greater legal certainty regarding tough legacy contracts, thus reducing the possibility of legal disputes preventing an orderly transition away from LIBOR. Information on this can be found in the House of Lords Library briefing on the critical benchmarks legislation.

3. Status of the transition

LIBOR was previously calculated for seven time periods and in five different currencies, giving a total of 35 versions. On 1 January 2022, however, the publication of 24 of the 35 LIBOR ‘settings’ ceased. Six sterling and yen LIBOR settings will continue for the duration of 2022 on a ‘synthetic’ basis. Five US dollar LIBOR settings will continue to be calculated using panel bank submissions until mid-2023, although its use for new business will be restricted from end-2021, with limited exceptions.

The Bank of England and the FCA published a statement on 9 February 2022 noting the progress that had been made in transitioning away from LIBOR. It stated that, in place of LIBOR, the SONIA benchmark was now “fully embedded across sterling markets” with trillions of pounds worth of financial transactions having successfully transitioned between the two measures. The Bank of England now estimates that, across all asset types, less than 2% of the total sterling LIBOR legacy stock remains.

Three synthetic sterling LIBOR settings (1-, 3-, and 6-month sterling) remain in place on a temporary basis to aid the final transition away from LIBOR. However, the Bank of England notes that transitioning contracts still relying on these to “permanent robust alternatives” remains the best way to “retain control and economic certainty over existing agreements”. In January 2022, the FCA stated that synthetic LIBOR rates are designed as a temporary bridge only and that their availability is “not guaranteed beyond end-2022”.

Following a consultation in June 2022, the FCA extended the intended cessation date of the 1- and 6-month sterling settings LIBOR by three months, to 31 March 2023. They are still considering an appropriate potential end date for the 3-month sterling setting. This is in the wake of consultation responses which suggested that the “orderly” transition away from LIBOR may be supported by the continuance of 3-month setting for a “limited period” beyond 31 March 2023.

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Cover image by Etienne Martin on Unsplash.