These ‘tough legacy’ contracts, which the FCA recently described as a “knotty problem”, pose a risk to market stability. The taskforce – and the working group it is a part of – are busy considering a number of possible solutions to take this problem away.

Key messages from the taskforce

The taskforce recognises the challenges in transitioning these contracts in mortgage portfolios to an alternative rate (particularly as there is no standardisation of contract terms across the market and a significant proportion of the LIBOR-linked mortgage contracts do not contemplate the cessation of LIBOR). The taskforce considers that there is a case for action to address tough legacy mortgage exposures, which will be welcomed by the mortgage industry.

To the extent that action can be feasibly taken, and accepting the challenges and dependencies required in delivering it, the taskforce proposes that the UK government considers legislation to address tough legacy exposures in contracts that are still in operation when LIBOR ends.

In particular, the taskforce makes reference to the proposal for legislative relief under New York law put forward by the equivalent working group in that state.

However, with considerable uncertainty about whether the UK proposal is feasible and could be delivered on time, the taskforce recommends that other solutions to the tough legacy problem should be pursued in parallel. For example, it floats the idea of LIBOR being stabilised via a so called ‘synthetic methodology’ for a wind down period following panel bank departure.

The taskforce concludes that the way for mortgage lenders and portfolio holders to have certainty over their contracts is to focus now on proactive transition of mortgage contracts away from reliance on LIBOR. This might not be as welcome a message, but lenders are advised to consider now their roadmap to a post-LIBOR portfolio.

Proactively transitioning away from LIBOR

There are a number of complex issues that mortgage lenders and portfolio holders will face when progressing their LIBOR transition strategy for legacy LIBOR-linked loans, including:

• Exploring the legal mechanism for transition: reviewing mortgage conditions across the legacy LIBOR-linked portfolio and determining the legal mechanism for transition.

• Determining the alternative rate: identifying the interest rate legacy LIBOR-linked loans will transition to and whether the replacement rate is comparable or equivalent to LIBOR (for the purposes of fall-back language in mortgage conditions). Firms will need to consider whether it is reasonable to use the alternative rate, taking into account whether it will result in the mortgage performing as the customer expected.

• Setting the communications strategy: the communications strategy will play a key role in ensuring good customer outcomes. Documentation provided to customers will need to be clear and transparent and customers will need to be given appropriate time to make an informed decision about what to do next. It will be particularly important for firms to reflect on any previous experiences of customer contact exercises and strategies that have been successful in achieving higher levels of customer engagement.

• Engaging with third parties: communicating with intermediaries and third party service providers on your LIBOR transition plan, and engaging with industry-led initiatives and (as necessary) regulatory bodies (taking into account obligations to deal with regulators in an open and cooperative way and disclose appropriately anything which the regulator would reasonably expect notice of).

• Conduct risk management: identifying and managing conduct risks associated with LIBOR transition, to ensure the fair treatment of customers. This includes developing an effective communications strategy and ensuring an appropriate governance and risk management framework (including senior management oversight) is in place to evaluate the possible options for transition and potential customer outcomes.

What’s next?

There is no guarantee that a legislative solution will materialise or that it would be available for all products and circumstances. Mortgage market participants should therefore continue their efforts to actively transition away from LIBOR before the end of 2021.

Given the significant legal, operational and conduct risks for market participants associated with the end of LIBOR, this is likely to remain high on the regulatory agenda and we expect the FCA to continue to engage with firms and increase its oversight of transition plans as we approach the end of next year.

Robin Penfold, partner at UK law firm TLT