In September 2018, the PRA and FCA wrote to the CEOs of major banks and insurers supervised in the UK to understand the preparations that were underway to manage the transition from LIBOR to SONIA (Sterling Overnight Index Average).
As the Dear CEO letter explained, repeating the words of Andrew Bailey, Chief Executive of the FCA from July 2018, lenders should treat the discontinuation of LIBOR "as something that will happen and which they must be prepared for".
Much has been written and said about the reasons why a more robust interest rate benchmark is required. It is not the purpose of this article to explore these reasons further. With the end of 2021 now less than three years away, we explore the points mortgage lenders should be considering so that they are suitably prepared for the transition.
LIBOR has been the interest rate charging mechanism for a range of lenders over the years, including those who have subsequently sold their mortgage books. Identification of impacted accounts is obviously a key starting point. With many lenders operating portfolios across various platforms, analysis should be undertaken to identify any portfolios to which LIBOR is applies.
The mortgage terms and conditions should be reviewed to understand what provision if any is made for alternative rates of interest to be charged. Points to be considered include –
Is a specific rate referenced or do the conditions reference an appropriate unnamed alternative?
If there is not any provision for an alternative rate, what do the conditions provide for with regarding to making a variation to the contract?
Is the variation clause drafted in such a way that it can be relied upon to change the basis upon which interest will be charged going forward?
Is the clause fair and capable of being relied upon? The FCA recently published their Final Guidance on the Fairness of Variation Terms in Financial Services (GC18/2).
If there is an inadequate variation clause or the terms and condition do not include any variation clause, the impact of this and the approach to be taken will require detailed consideration.
The mortgage terms and conditions will in due course and before 2021 require variation to accurately set out the basis upon which interest is to be charged in the future.
Where lending is still being undertaken on a LIBOR basis, new customers should be made aware of the impending change to the basis on which interest will be charged. In due course, the mortgage conditions will need to be revised.
It will be necessary to assess how the mortgage account system will deal with the change from LIBOR to SONIA. Is it simply a matter of renaming the applicable interest rate on the system or are there added complexities in terms of how the calculations are undertaken within the mortgage account system?
Consideration must be given to what will need to change within the system and in letters and account statements to reflect the new rate in communications to customers.
It is important that there is a clear strategy to advise customers of the change. Customers will be concerned to understand what the change will mean for the interest rate they are being charged and the impact, if any, on their monthly payment. Customers may simply accept that LIBOR is being discontinued and that SONIA is the replacement model being used. Others might want to understand more about SONIA, might wish to discuss this, and may want to understand why they are not being linked to Bank of England base rate or some other rate. When a contact strategy is being planned, lenders will need to ensure that they have appropriate resource in place to deal with queries that are raised.
There is clearly much to be done over the coming three years in preparation for the discontinuation of LIBOR. Our Mortgage Regulatory team will be pleased to discuss with you how we can assist.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2019. Specific advice should be sought for specific cases. For more information see our terms & conditions.