Central banks and market regulators in Europe, the U.K. and the U.S. are accelerating the transition away from the use of Libor as a benchmark for interest rates. Andrew Bailey, the chief executive of the U.K.'s Financial Conduct Authority, brought the issue into focus with a speech on July 27, in which he announced a change in the FCA's position. In 2012, the FCA, then under the leadership of Martin Wheatley, opted for reforming Libor rather than replacing it. Bailey said, however, that while significant improvements have been made to Libor, the absence of active underlying markets "raises a serious question" about the benchmark's sustainability. He announced that the FCA would cease to put any obligation on banks to support the benchmark by the end of 2021 and emphasized that the industry needed to step up the preparations for a transition to alternative reference rates based on transactions rather than judgements.
One candidate to replace Libor in the U.K. interest rate market is the Sterling Overnight Index Average, or Sonia, which is based on actual trades in the U.K. overnight unsecured lending and borrowing market. The Bank of England, which took over administration of this rate in April 2016, has undertaken several reforms to strengthen the benchmark and broaden the range of transactions on which it is based. In April 2017 a working group of market participants sponsored by the Bank of England announced that it supported Sonia as its preferred benchmark. Chris Salmon, the Bank of England's executive director for markets, described this as "the first step on the path towards the adoption of a sterling risk-free rate as an alternative to Libor."
Meanwhile in the U.S., preparations for the transition away from Libor accelerated in June, when the Alternative Reference Rates Committee, a group of private market participants convened by the U.S. authorities, announced that it had selected the financing rate for Treasury repurchase agreements as an alternative for Libor as a benchmark for U.S. dollar denominated derivatives. The ARRC also said that it will outline transition plans and implementation options in the coming months.
Separately, the Federal Reserve Bank of New York and the Treasury Department's Office of Financial Research indicated that they expect to begin daily publication of the new benchmark in the first half of next year. And on July 26, CME Group announced that it plans to develop futures and options on the Treasury repo financing rate. CME, which is a non-voting member of the ARRC, said the new contracts would be "complementary" to its Eurodollar futures, which are tied to Libor, and its other interest rate futures.
Most recently, four European authorities on Sept. 21 announced the formation of a working group to identify an alternative benchmark for Euro-denominated financial instruments. The four authorities—the European Central Bank, the European Commission, the European Securities and Markets Authority, and Belgium's Financial Services and Markets Authority—will first make a recommendation on their preferred alternative risk-free rate and then explore possible approaches for ensuring a smooth transition and broad market acceptance. In addition, the ECB announced that it will start providing an overnight unsecured index before 2020 in order to widen the set of options for such alternative rates.
