Working Group on Sterling Risk-Free Reference Rates Asks Regulators to Act on Prudential Impediments to LIBOR Transition

The Working Group on Sterling Risk-Free Reference Rates has written to the Prudential Regulation Authority raising issues in the banking prudential regulation regime that, in its view, will require changes and/or regulatory forbearance if a smooth transition from LIBOR to SONIA is to be achieved. Although the letter focuses on the U.K. regime, the issues are likely to be relevant globally.

The prudential issues that may impact banks in the transition from LIBOR that are highlighted by the Working Group include: (i) the potential for certain capital instruments to no longer qualify as regulatory capital; (ii) the potential for securitizations and MREL-eligible instruments to be considered as "new contracts" as a result of changes to contractual terms, leading to the need to insert bail-in or other bank recovery contractual terms; and (iii) that many banks will need to obtain regulatory approvals for alterations to the models used to determine their regulatory capital arising from their exposures and risks.

The Working Group makes the following recommendations and requests:

• Model Change Assessments: regulatory forbearance or a transitional period and/or rule amendments to allow firms to use current benchmarks as proxies, and where possible, backfill to mitigate against unnecessary capital needed resulting from changes to internal models.
• Counterparty Exposure: regulatory forbearance to mitigate the potential increased costs to corporate end-users resulting from increased capital related to increased margin period of risk.
• Contractual Terms: supervisory statements clarifying that the transition to RFRs will not trigger the requirement to insert relevant contractual terms into MREL-eligible instruments or result in existing securitizations losing their grandfathered status.

The letter includes an annex setting out in detail the impediments to firms transitioning to the RFRs as well as general prudential effects of implementation of the transition framework and related issues that arise.

View the Working Group's letter.

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