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Economy 9 December 2021

Notice of prohibition of new use of USD LIBOR

With just under 1 month left until the formal cessation date of the majority of the LIBOR tenors and currencies, the United Kingdom’s Financial Conduct Authority (“FCA”) has formalized guidance around issuances of new USD LIBOR-linked exposures from the end of 2021.

In the Notice of Prohibition published on 16 November 2021, the FCA sets out the limitations on supervised entities entering into contracts / exposures  referencing the LIBOR settings that will continue to be published until June 2023, being the overnight, 1 month, 3 month, 6 month and 12 month USD LIBOR settings (referred to as “Prohibited USD LIBOR Versions” in the Notice).

The continued availability of the Prohibited USD LIBOR Versions has been the subject of much debate and discussion since the formal cessation dates were announced in March 2021. Whilst it was clear that the differentiated treatment of the Prohibited USD LIBOR Versions was meant only to alleviate the transition burden for USD LIBOR legacy contracts (by keeping these settings alive for long enough to allow market participants sufficient time to transition their exposures without causing a cliff edge at the end of 2021), it was unclear how or if it would remain possible to reference the Prohibited USD LIBOR Versions in new contracts going forward, for as long as these settings remained available. This notice of prohibition expands on the guidance issued by the various industry bodies throughout 2021 and seeks to clarify the expectations of market participants, as well as set out the consequences of breaching the prohibition.

What is prohibited?

 According to the FCA, supervised entities (and third country supervised entities) are prohibited from referencing the Prohibited USD LIBOR Versions in any new contracts post end December 2021 (ie the prohibition takes effect on 1 January 2022), subject to certain limited exceptions.

What exceptions apply?

The notice of prohibition lists the following 5 exceptions:

  • Market making in support of client activity related to US dollar LIBOR transactions executed before 1 January 2022 (this only applies where the market making is undertaken in response to a client seeking to hedge or reduce their USD LIBOR on contracts entered into before 1 January 2022.)
  • Transactions that reduce or hedge the supervised entity’s or any client of the supervised entity’s US dollar LIBOR exposure on contracts entered into before 1 January 2022
  • Novations of US dollar LIBOR transactions executed before 1 January 2022
  • Transactions executed for the purposes of participation in a central counterparty auction procedure in the case of a member default, including transactions to hedge the resulting US dollar LIBOR exposure
  • Interpolation or other use provided for in contractual fallback arrangements in connection with the US dollar LIBOR Versions that will cease at 31 December 2021 (the 1-week and 2-month USD LIBOR Versions)

The prohibition notice does not prohibit new single currency USD LIBOR basis swaps entered into in the interdealer broker market (to the extent it would constitute new use). In line with the FCA notice, much of the supervisory guidance issued to date does limit “new” use of USD LIBOR. It is therefore imperative to understand what would constitute “new” use. According to US Supervisory guidance a new contract would include an agreement that (i) creates additional LIBOR exposure for a supervised institution or (ii) extends the term of an existing LIBOR contract.

What happens if market participants continue to reference USD LIBOR in new trades from 1 January 2022?

Supervised entities and supervised third country entities may be subject to FCA enforcement action for contravening the prohibition. The notice also refers to support for the FCA’s approach, from both the Financial Stability Board and IOSCO. The notice further emphasizes the “concerted and globally consistent supervisory expectation regarding stopping new use of the prohibited LIBOR settings.” It’s also important to note that South African regulators, and in particular the Prudential Authority and the South African Reserve Bank, have expressed their expectation that South African market participants follow the guidance issued by LIBOR’s home country regulators.

The Standard Bank Group is committed to following best practices in the LIBOR transition journey, as well as the supervisory guidance issued to date. As a result, in line with the FCA guidance and our own regulators’ expectations, the Standard Bank Group will be assessing all requests to reference USD LIBOR in new exposures against these requirements. We may also request our clients to evidence that trades or requests to trade submitted to the Standard Bank Group from 1 January 2022 will be in compliance with the restrictions set out in the Notice of Prohibition (for example, evidence that a client seeks to hedge legacy USD LIBOR exposures).

We remind all market participants to actively take steps to reduce their reliance on LIBOR, and to understand the impact of the transition away from LIBOR on their business, particularly in light of the expectations communicated in the Notice of Prohibition.