The first task for the Group is to identify the most appropriate near riskfree reference rate for sterling markets. Alongside that you will consider how contracts referencing the rate can be made robust to changes in market structure. We expect these discussions to reach a conclusion during the third quarter of this year. The Group will then develop an adoption and transition plan over the remainder of 2015, considering the factors that could facilitate adoption of the chosen RFR, as well as metrics of success and a timeline for the transition process. It is anticipated that firms participating in the Working Group will sign letters of agreement to support adoption of the chosen RFR, referencing these metrics. Implementation is expected to begin in 2016. We believe that this needs to be a market-driven process and that the choice of RFR is yours to make. However, this is not an academic exercise. A “choice” means that you will be prepared to make meaningful transition commitments over a 12 to 24 month horizon. Bank of England data collection initiative Before I hand over to you all to begin the important work of this Group, I want to make you aware of a new initiative the Bank is embarking on, aimed at enhancing our measures of overnight interest rates in sterling markets. The Bank has a special interest in monitoring the overnight money market because it is a key aim of monetary policy to influence conditions in that market.
The FSB’s recommendation to develop alternative reference rates alongside LIBOR recognises that there are, broadly speaking, two main applications for benchmark interest rates: (i) as reference rates in credit products, including bank loans, thereby helping banks to hedge their unsecured funding costs; and (ii) as reference rates in derivatives contracts, whose users are likely to be seeking to hedge exposure to the general level of interest rates, or to hedge secured funding costs. LIBOR originated as a reference rate for bank loans, and became the dominant reference rate in interest rate swap contracts because it was already the major established reference rate at the time the swap market developed. However market participants’ input to the FSB report suggested that many users of derivatives would prefer not to have exposure to banks’ term funding costs through LIBOR swaps, and would instead prefer those contracts to reference a near risk-free rate. This change will not happen spontaneously – liquidity in long-dated swaps is firmly concentrated in contracts referencing LIBOR and no individual player can change that situation. What is required is a collective effort to change market practice. That is why we have initiated the Working Group on Sterling Risk-Free Reference Rates. It will be tasked with identifying a suitable near risk-free reference rate for sterling markets, and formulating a transition plan to catalyse a change in market practice so that a significant portion of derivatives contracts reference the new RFR rather than LIBOR.