The end of LIBOR: legal and regulatory challenges for mortgage lenders

It is estimated that there are currently around 200,000 LIBOR-linked residential and buy-to-let mortgages in the UK. LIBOR is deeply embedded in business practices in the mortgage market, particularly in the specialist lending sector, and understandably there is a great deal of uncertainty to be addressed before many mortgage lenders will feel confident in their LIBOR transition programmes.

There are three key messages being delivered by regulators:

1. Waiting for development of an alternative term rate is not an acceptable reason for firms to delay taking action;
2. Working on the assumption that LIBOR will still exist in some useable form post end-2021 is not a viable strategy;
3. Customer communication will be critical throughout the LIBOR transition.

Although the FCA has recently published a question and answer statement outlining their expectations for firms on mitigating and managing conduct risk during LIBOR transition, there remain a number of unanswered questions.

What are the key challenges for mortgage lenders?

• Governance and accountability: the FCA has set out very clearly in its most recent Q&A that responsibility for LIBOR transition should form part of a firm's SM&CR and conduct risk management framework, and that firms should identify the Senior Manager responsible for overseeing the transition.
  
  Putting an appropriate governance framework around your LIBOR transition programme is key. We expect regulators to increase their oversight of firms’transition plans as we get closer to end 2021.

• Using an alternative reference rate: at the time of entering into LIBOR-linked mortgage contracts, it is unlikely that the parties will have contemplated that LIBOR would cease to be published during the life of the contract. Where fall-back clauses exist, firms need to consider whether these are flexible enough to accommodate a permanent change to an alternative reference rate, where typically these were only designed for use in cases of temporary LIBOR disruption. Where they don’t, firms will need to consider a range of alternative options, including consensual variation of the terms.

  Substituting one rate for another in a mortgage contract is likely to lead to a transfer of value (one party will lose and another will gain), which will need to be addressed as part of the transition plan. If appropriate provision is not made to re-balance this value transfer, there is a risk of disputes.

  Recognising the complexity associated with the transition of legacy contracts away from LIBOR,  the Working Group on Sterling Risk-Free Reference Rates has recently announced the mobilisation of three new task forces including the Tough Legacy Task Force (to identify and mitigate the extent of contracts unable to convert away from LIBOR) and the Cash Market Legacy Transition Task Force (to highlight approaches to convert existing contracts or update contracts to include robust fall-back language). It is likely that further industry guidance on treatment of legacy contracts will follow.

• Managing the impact on funding arrangements: a number of funding models are used across the mortgage market including warehouse lines, forward flow agreements, securitisations and retail funding. Firms will need to consider any knock-on effect of their LIBOR transition programme on their funding arrangements.

• Communicating the changes to customers: the FCA expects firms to engage with customers both generally on the implications and timing of the LIBOR transition, and by planning for and rolling-out a client-specific communication strategy. However, mortgage lenders need to strike the right balance between early engagement with customers and having sufficient clarity themselves about their LIBOR-transition plans to deliver the key messages clearly and in a way that is appropriately targeted to the knowledge and experience of the intended audience.

So, what's next?

There are significant contractual, risk, operational and conduct management challenges associated with the end of LIBOR.

It is likely that the FCA will continue to engage with firms and increase its oversight of transition plans as we approach end-2021. Although industry initiatives are underway and market consensus is building (particularly in trying to reach agreement on fair replacement rates), what is clear is that the FCA does not expect mortgage lenders to wait for any further guidance, but to be developing and implementing their LIBOR transition strategies now.

This article was first published by Mortgage Finance Gazette.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2020. Specific advice should be sought for specific cases. For more information see our terms and conditions.