We remain committed about both the need for the market to continue to drive transition forward moving new 7  All speeches are available online at www.bankofengland.co.uk/news/speeches  7  issuance onto alternative rates and converting legacy exposure where possible; and also to ensuring there is a solution for those contracts that legitimately cannot be converted from Libor. That is why the UK government announced last month its intention to legislate to provide the FCA with increased powers to deliver an orderly wind-down of critical benchmarks, such as Libor. 7 It remains in the interests of financial markets and their customers that the pool of contracts referencing LIBOR is shrunk to an irreducible minimum ahead of LIBOR’s expected cessation, leaving behind only those contracts that genuinely have no or inappropriate alternatives and no realistic ability to be renegotiated or amended. Those that decide to rely on regulatory action, enabled by the legislation the UK Government plans to bring forward, will not have control over the economic terms of that action.
And central bank facilities such as the Bank of England’s Term Funding Scheme have offered a cost effective source of funding to support additional lending to the real economy, providing insurance against adverse conditions in bank funding markets. These changes have led many banks to choose simply not to borrow in unsecured markets as the costs increase. Overall, this leaves Libor rates capturing (at best) only a tiny fraction of overall funding costs even in benign market conditions. As transactions become scarce during periods of stress, this reduces yet further. For example, during March and April Libor rates were impacted by liquidity mismatches in money market activity. Money Market Funds, that are important investors in unsecured bank funding markets, experienced large outflows, the so called ‘dash for cash’. This meant Libor linked borrowers were immediately exposed to a sharp increase in rates driven by these more esoteric liquidity factors in addition to any perceived changes in bank credit risk. When the banks that provide the data on which the Libor rates are based can’t reference actual transactions that they have undertaken, they are asked to provide Libor’s administrator with a submission based on transactions in other markets, where they are able. More commonly though, those data aren’t available either, so they have to rely on ‘expert judgement’ which is an estimate of the rates that the firm would expect to pay in those wholesale unsecured funding markets.