Time to engage - Bank of England’s Alastair Hughes offers advice on preparing for LIBOR transition

Time to engage - Bank of England’s Alastair Hughes offers advice on preparing for LIBOR transition

[Music] aleister welcome to trade finance talks tv great it's great to be here thank you so thank you for joining us what's your what's your elevator pitch who are you where are you from and what do you do my name is aleister hughes i work at the bank of england i work in the markets area of the bank uh and one of the things we look at is uh is market structure and making sure there are fair and efficient markets uh for everyone in the uk one aspect of that is uh its financial benchmarks and particularly the libor benchmark it's it's a name that often kind of resonates with people but libor is coming to an end uh necessarily coming to an end and we work to try and help businesses and end users move away from the libel rate as swiftly and safely as possible yeah and some people call it the world's most important number some 300 trillion dollars of of contracts involved in libel can you give us a bit of a history of libor and and why it exists and also why its demise has been recommended sure so um libra's a financial benchmark benchmarks are really important they provide transparency they provide consistency and they provide somewhere where we can coalesce and manage risk and ultimately that that reduces costs for people which is a a good thing in markets um libor has been around for for 30 40 years different stories of its origins but sort of the late 60s it emerged in the syndicated lending market and the idea being to have a benchmark or a reference rate that reflected bank's cost of funding at that time it reflected the interbank funding market now what has happened in those 40 years libor has become very embedded in the financial system we've seen it used across a whole range of products much wider than it was intended from mortgages to derivatives to lending products but the markets on which it based and these benchmarks do need to be represented those markets is just not active anymore certainly since the global financial crisis banks have moved away from funding in those interbank markets and there's no longer sufficient transactions underpinning the market to support it so the banks that provide the data aren't going to do that liable rates are going to cease for new use at the end of this year so people need to make sure they're ready to move to alternatives um and they have plans in place for their legacy libor exposure and we're here to help with that thanks alistair so what are the key changes in terms of libor's replacement so there are different uh recommended rates in each of the currency jurisdictions in sterling market um an industry group back in 2017 recommended sonia sonia is a rate produced by the bank of england it's underpinned by a strong underlying set of real transactions it's data that's collected by the bank of england and it's built to be robust and to reflect as i say those real underlying transactions now sonia is an overnight rate that makes it very robust but it also means that while overnight rates are very familiar in derivatives markets some changes and adaptions need to be made to it for it to be used in lending markets to be closer to the the free month uh tenors that we're used to one of the other differences is as an overnight rate sonya has to be either compounded in arrears or turned into a forward term rate uh whereas libor is a forward term rate at the start of the interest period you will know what your liable payment is it's one of the things people like is also one of the aspects that makes it weaker than some of these robust overnight rates and lastly libor includes risk premier that is not in sonja sonora is what is called a risk-free rate libel has some quite opaque credit and liquidity risk in there so there's a small difference between them often people talk about something called the credit adjustment spread which is the difference between the two thanks alistair so what are the next steps in terms of the road the road map as we kind of transition from from libel to sofa so yeah i mean that deadline is coming up on us pretty quickly libel will will sterling libel will cease at the end of this year new use of all the libel currencies will come at the end of the year but the important thing is there is time and there is help available so as i say new use of libel will cease from the end of this year in sterling markets the sonia alternative we've talked about is now well embedded the sonia product set is very liquid it's available it accounts for 80 of new linear derivatives trading the whole range of risk management products people will be familiar with caps and floors and swaptions are available in sonia and uh since april this year sonia link lending has been one of the main products put forward and there's well over 50 billion of sonia link lending being used by all types of sectors and all types of facilities now so the new products are in place so what i say to you is if you're being offered liable products today stop think about it ask your provider certainly sterling that product set is there then i'd say check your other library exposure so if you've got historic libor exposure that runs beyond 2021 in sterling you're going to need to think about what reference rate you would use going forward we've been encouraging people to look at those contracts and amend those rates if they can with their customers there's huge amounts of help and advice out there you know on the bank of england website indeed you know you've got your own resource so look at that that can tell you about this credit adjustment spread and how to move fairly from one rate to the other and lastly if you're dealing with contracts which are what people tend to prefer as tough legacy or stock contracts there's help in place there now this is a safety net it should be looked upon as a safety net but my colleagues at the financial conduct authority will produce something called synthetic libor as a temporary bridging measure it won't be in place forever but what it will do is make sure there's no break in the availability of rates for those contracts so understand your exposure to libor plan and look to move across as soon as possible thanks alistair and and of course in respect to trade finance you know what are you what are you seeing in the market in terms of perhaps term rates versus versus you know compounded overnight and arrears rate uh so certainly we expect compounding and urea sonia to be the most widely used rate in sterling markets it's where the the most liquidity will be but we have always recognized that a term product will be um necessary for certain parts of the market and so we've been working with the industry for well over sort of three or four years now to make sure those rates are available in sterling markets there are two terms on your reference rates available from two well-known benchmark providers those rates have been live for use in contracts since january this year and there's very clear guidance on on who should use those rates those guidance put out by the risk-free rate working group which is an industry group set up by the bank of england there's also further guidance from the financial industry market standard board the thick market standard board now elements of trade finance and discounting do require that forward term rate we recognise that and that rate is live and active in there for people to use today we also recognize in other currencies that's important dollar finance particularly important and again in the us sofa which is the recommended alternative to dollar libor has a term rate available provided by cme in the us and that's available to use as well thank you very much so for those trade finance participants who are you know still i guess finding finding their way through the transition what did what advice would you would you give so first i'd say if you're burying your head in the sand uh because someone's told you libel is going to continue or you don't have to do anything that's definitely not the case libel will cease the journeys look slightly different in different currencies but the destination is the same so you do need to engage you need to understand what your exposure to the libel rate is both in terms of future use of products and indeed those legacy products and indeed if you use libor in pricing or valuation models you then need to work to have a plan to transition across as i say your financial service provider will normally bear to help you with that there's huge amounts of guidance from trade associations from the bank itself i'd kind of look at these safety nets as i say these kind of synthetic libra in the uk or other areas in the us as kind of safety nets i'd engage look at these recommended adjustment spreads and look at moving across to either sonja prost the adjustment spread or sofa plus the adjustment spread or what what works in those specific situations so where possible on those legacy contracts renegotiate them if they're contracts they're going to be difficult to renegotiate look what legal basis that contract is on whether it's on uk law u.s law and make sure you have either a bus fallbacks in place or you understand the mechanism that's going to transition those contracts and make sure you're speaking to your con you know your clients and your financial service providers about that but the most important thing is to engage and if you do engage there is help and support out there for you thank you very much alistair engage absolute key there and i must plug the uh the it for tfg uh libel for trade finance hub on trade finance global dot com forward slash libel thank you [Music]

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