We have worked with other regulators, trade associations and market participants to enable liquid markets in SONIA derivatives to help the transition from LIBOR. We explain what our work means for firms.
Building derivative market liquidity in alternative rates
Alongside the Bank of England, we have undertaken several initiatives to build liquidity in SONIA derivative markets. The FCA and Bank of England have worked with market participants to encourage use of SONIA rather than LIBOR from a series of dates in specific products to develop the SONIA ecosystem and reduce the risk of cliff-edges on regulatory milestones.
From 27 October 2020 participants in the sterling interdealer interest rate swaps market were encouraged to change the quoting convention from GBP LIBOR to SONIA.
From 11 May 2021 participants in the sterling interdealer non-linear derivatives were encouraged to change the quoting convention from GBP LIBOR to SONIA.
From 17 June 2021 market participants were encouraged to switch the default trading instrument in sterling exchange traded derivatives to SONIA instead of LIBOR.
From 21 September 2021 liquidity providers in the cross-currency interest rate swaps market were encouraged to adopt new quoting conventions for interdealer trading based on risk-free rates instead of LIBOR.
A similar initiative was recommended by the CFTC’s Market Risk Advisory Committee’s Interest Rate Benchmark Committee[5] to shift liquidity from USD LIBOR to SOFR in interdealer interest rate swap markets. This has been modelled on the SONIA initiatives. The FCA and the Bank of England have encouraged[6] all participants in the interdealer US dollar interest rate swaps market to take the steps necessary to prepare for and implement these changes to market conventions on 26 July and shift liquidity away from USD LIBOR to SOFR.
Enhancing contractual robustness in the derivatives market
On 23 October 2020, the International Swaps and Derivatives Association (ISDA) launched its IBOR Fallbacks Supplement to the 2006 ISDA Definitions[7] and the ISDA 2020 IBOR Fallbacks Protocol[8]. The FSB’s OSSG had asked ISDA to lead the work on derivatives robustness and ISDA consulted on how best to calculate fair replacement rates for LIBOR. Through the FSB, authorities globally have strongly encouraged[9] adherence to the Protocol, which came into effect on 25 January 2021 for all adhering parties.
The Protocol is an important tool in facilitating transition to alternative rates for legacy LIBOR derivative contracts, with over 14,000 firms now signed up to the Protocol. The Protocol remains open for adherence. See the ISDA's information on how to do this[10].
LIBOR transition and firms’ obligations under UK EMIR
The transition away from LIBOR in the derivatives market interacts with certain obligations under the UK European Market Infrastructure Regulation on Derivatives[11] (UK EMIR). We have taken steps to clarify our expectations.
The FCA’s view is that amending a reference rate or adding a fallback would not trigger the application of margin or clearing requirements under UK EMIR, where this amendment relates to the treatment of legacy LIBOR trades (as set out previously in the minutes[12] of the Working Group on Sterling Risk-Free Reference Rates meeting of 7 November 2019, paragraph 23).
We have also clarified our expectations[13] regarding reporting requirements under UK EMIR in the context of LIBOR transition and the operation of contractual fallbacks (see our March and July 2021 EMIR news updates).
LIBOR transition and firms’ obligations under MIFIR
We have outlined our expectations[14] regarding the effect of LIBOR transition for transaction reporting under RTS 22 and reporting of instrument reference data under RTS 23.
Derivatives Clearing and Trading Obligation
The Bank of England consulted[15] on its proposal to modify the scope of contracts which are subject to derivatives clearing obligation to reflect the ongoing reforms to interest rate benchmarks. This consultation closed on 14 July 2021 and the Bank of England has now published a Policy Statement[16].
The Bank of England subsequently consulted[15] on its proposal to add overnight index swaps (OIS) that reference TONA to the scope of contracts which are subject to derivatives clearing obligation. This consultation closed on 27 October and the Bank of England has now published a Policy Statement[16].
We consulted[17] on the consequences of LIBOR transition for the derivatives trading obligation (DTO).
This consultation closed on 25 August 2021 and we have now published a Policy Statement (PS21/13)[19].
We are removing derivatives referencing GBP LIBOR from the current DTO and replacing them with OIS referencing SONIA. These changes come into force on 20 December 2021.
We recognise that the liquidity profile of the derivatives market will continue to evolve as interest rate benchmark reform unfolds. As a result, we may propose further amendments to the scope of the derivatives trading obligation in due course.
