Following close engagement with market participants, and to support the US-led ‘SOFR First’ initiative, the FCA and Bank of England support and encourage liquidity providers in the US dollar linear interest rate swaps market to adopt new trading conventions for interdealer trading based on SOFR instead of LIBOR from 26 July this year. This is to facilitate a shift in market liquidity towards SOFR, bringing benefits for a wide range of users as they move away from LIBOR.
Guidance from US regulators[1] is that banks in the US should cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and no later than the end of 2021.
Similar guidance was issued to regulated firms in the UK by the PRA and FCA in a ‘Dear CEO’ letter[2] in March, and has been reinforced globally by the Financial Stability Board.[3]
In support of this guidance, the CFTC’s Market Risk Advisory Committee’s Interest Rate Benchmark Reform Subcommittee (MRAC Subcommittee) voted to recommend[4] 26 July 2021 for switching interdealer trading conventions for USD linear interest rate swaps from USD LIBOR to SOFR.
To determine support for, and the feasibility of, a similar approach in the UK to support the US-led initiative, the FCA has engaged with UK market participants in the US dollar interest rate swaps market, including liquidity providers and interdealer brokers (IDBs).
An FCA survey of these market participants identified strong support for a change in the interdealer trading convention, which would see SOFR rather than LIBOR become the default price from 26 July 2021.
In line with the MRAC Subcommittee’s recommendation, the FCA and the Bank of England support and encourage all participants in the interdealer US dollar interest rate swaps market to take the steps necessary to prepare for and implement these changes to market conventions on 26 July and shift liquidity away from USD LIBOR to SOFR.
Background & technical notes
The proposed change will involve IDBs moving the primary basis of their pricing screens and curve construction for interest rate swaps from USD LIBOR to SOFR.
At present, SOFR swaps are priced by default by reference to a LIBOR swap adjusted by the LIBOR-SOFR basis. As a result of this change, SOFR swaps would be the primary pricing point.
LIBOR swaps would therefore be priced by reference to SOFR swaps adjusted by the LIBOR-SOFR basis.
The same change would be made in the trading of swap spreads (swaps against bonds) in US dollar markets, such that the default pricing will show SOFR swaps relative to US Treasuries.
For the avoidance of doubt, from 26 July 2021, the FCA and the Bank of England encourage all trading in USD LIBOR swaps, and USD LIBOR-based swap spreads in the interdealer broker market to be replaced with trading in SOFR swaps and SOFR-based swap spreads.
USD LIBOR is expected to be accessible only as a basis swap to SOFR in the interdealer broker market from this date. However, screens for outright LIBOR swaps and LIBOR-based swap spreads are expected to remain available for informational purposes, but not trading activity, until 22 October 2021. After this date, these screens would be turned off altogether.
For further detail, see the MRAC Subcommittee’s SOFR First Frequently Asked Questions here[5].
FCA survey results
Survey sent to 19 participants - 1 abstention.
Q. Do you support a ‘SOFR-First’ Convention Switch for the US dollar interest rate swaps market in the UK on 26 July 2021 in line with the MRAC Subcommittee’s recommendation? Yes / No.
Total ‘Yes/No’ respondents: 18.
100% of ‘Yes / No’ respondents selected ‘Yes’ to this question.