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FAQs on switch to 'SONIA First' for GBP exchange traded derivatives from 17 June

Trading in new sterling interest rate futures and options to move from GBP LIBOR to SONIA from 17 June

11 June 2021

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The UK interest rate futures and options market has entered the final stages of its changeover to a new interest rate benchmark following the UK Financial Conduct Authority's announcement of the cessation of panel bank GBP LIBOR on 31 December 2021.

GBP LIBOR is being replaced in sterling-denominated interest rate derivatives by the Bank of England's Sterling Overnight Indexed Average rate, or SONIA, and the spread between GBP LIBOR and three-month compounded-in-arrears SONIA has been fixed at 11.93bps from the end of 2021.

As part of a 'SONIA First' initiative, the Bank of England and FCA are encouraging all market participants and liquidity providers in the sterling exchange traded derivatives market to switch the default traded instrument to SONIA instead of LIBOR from 17 June. Liquidity is therefore anticipated to shift away from LIBOR-referencing ETDs and into SONIA, making it increasingly expensive for firms that delay making this transition.

In a recent Dear CEO letter, the PRA and FCA stated they expect all regulated firms to meet the milestones set out in the roadmap of the Working Group on Sterling Risk-Free Reference Rates.

In response to requests for concise information on the process and timelines FIA has developed the following FAQ to assist market participants, including end clients:

What is the timeline?

The Bank of England and FCA have encouraged market participants and liquidity providers to switch the default traded instrument to SONIA instead of LIBOR from 17 June, and to implement changes to standard trading conventions.

This timeline is driven by the Working Group on Sterling Risk-Free Reference Rates, which published a series of milestones outlining the process to shift volumes from GBP LIBOR to SONIA.

Specifically, the Working Group recommended that by the end of June this year, market participants cease the initiation of new GBP LIBOR-linked exchange traded derivatives that expire after the end of 2021, except for the risk management of existing positions.

Can I still trade LIBOR contracts after 17 June?

Contracts that expire before the end of 2021 can continue to trade as normal.

Contracts expiring after end 2021 should only be traded for "risk management of existing positions" from the end of June. Definitions of the risk management exceptions are set out in the Working Group's "Path to ending new use of GBP LIBOR-linked derivatives" and include transactions that reduce or hedge a firm's, or client's, GBP LIBOR exposure.

In a paper on active transition of LIBOR contracts, the Working Group encourages active transition ahead of the cessation date in order to ensure certainty and so firms retain economic control.

As the Dear CEO letter notes: "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 cessation."

What happens if I do not transition in the market?

Any remaining open positions in GBP LIBOR-referencing futures and options will be converted to SONIA contracts via fallback plans administered by exchanges. These are fallback plans and should be viewed as such.

The ICE Futures Europe fallback plan will convert all remaining open interest in Three Month Short Sterling contracts into Three Month SONIA Index contracts following close of business on 17 December. The conversion will be applied on a 2:1 basis due to different notional values and, in certain circumstances, positions could be cash settled.

CurveGlobal is currently consulting on its LIBOR transition proposals and expects to confirm its plans following the end of the consultation period on 25 June.

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