Collateral referencing LIBOR
Update on the impact of Covid-19 on the interim milestones for the Bank’s LIBOR linked collateral haircut and eligibility policy.
The central assumption remains that firms cannot rely on Libor being published after the end of 2021. Recognising the challenges caused by the current operating environment and after considering the implications of the temporary disruption caused by Covid -19, as well as the changes published to the interim milestones announced by the Working Group on Sterling Risk Free Rate Transition on 29th April, the Bank has decided to revise the interim milestones for its LIBOR linked collateral and haircut policy.
The haircut glide path for all LIBOR linked collateral maturing after end-2021 will now be phased in from 1 April 2021 (revised from 1 October 2020). Further, from 1 April 2021 (revised from 1 October 2020), newly issued LIBOR linked collateral will be ineligible for use in the SMF.
The policy objective remains to encourage forward planning by both the Bank and SMF members to ensure that borrowing capacity is maintained and that public money is appropriately protected against the risks of a disorderly LIBOR transition. As the central assumption remains that firms cannot rely on LIBOR being published after the end of 2021, the end point of the haircut glide path is unchanged and will result in haircuts of 100% by end of 2021, at which point all LIBOR linked collateral will cease to be eligible for use in the SMF.
The Bank’s revised policy for collateral referencing LIBOR for use in the Sterling Monetary Framework is detailed in this Market Notice, published on 7 May 2020.
UPDATE: On 29 April, the Working Group on Sterling Risk Free Rate Transition (RFRWG) has published changes to the interim milestones it published in January 2020 to support the transition from Libor due to the temporary disruption linked to Covid-19. The central assumption remains that firms cannot rely on LIBOR being published after the end of 2021.
The Bank recognises the need for borrowers and lenders to focus on core activities during this period of temporary disruption and expects to provide the market with an update on its Libor linked collateral haircut and eligibility policy shortly.
The Bank’s policy with regards to collateral referencing LIBOR for use in the Sterling Monetary Framework is detailed in this Market Notice, published on 26 February 2020.
The policy objective is to encourage forward planning by both the Bank and SMF members to ensure that borrowing capacity is maintained and that public money is appropriately protected against the risks of a disorderly LIBOR transition. The policy adopts a haircut glide path for all LIBOR linked collateral maturing after end-2021, that will be phased in from 1 October 2020 and result in haircuts being 100% by end 2021, at which point all LIBOR linked collateral will cease to be eligible for use in the SMF. Further, from 1 October 2020, newly issued LIBOR linked collateral will be ineligible for use in the SMF. The Bank considers that this approach should act as an additional incentive both to cease new LIBOR issuance in cash markets and to amend legacy LIBOR linked collateral.
The FPC has made clear that continued reliance of global financial markets on LIBOR poses a risk to financial stability that can only be reduced only through a transition to alternative risk-free rates by end-2021. These risks can only be fully mitigated by removing any links to LIBOR ahead of that date, but the Bank also views broad adoption of robust fallback language as an important risk mitigant. Finalisation and adoption of market standards for robust fallbacks remains in progress, including through the exercise undertaken by ISDA with respect to derivative markets. The Bank will monitor these market developments and will keep under review the potential to distinguish between LIBOR Linked Collateral with robust fallback language and that without, as market practice develops.
In June 2019, the Bank of England published a discussion paper that sought feedback on the Bank’s Framework. The paper outlined a number of risk management approaches under consideration by the Bank to ensure that it remains well placed to provide liquidity insurance in support of financial stability.
The Bank received 20 responses to the Discussion Paper. Responses were received from banks and building societies, of a range of size and business model, all of which are members of the SMF, although the discussion was open to the entire market. Key themes from these responses are discussed below: