Legislative solutions to tough legacy contracts are passed into UK law
On 29 April 2021, the Financial Services Act 2021 (“the Act”) received Royal Assent and became law in the United Kingdom. The Act introduced reforms to a number of key UK financial services frameworks, which also represent the first major changes to the UK regulatory landscape following the UK’s departure from the European Union on 31 December 2020. One area of reform includes amendments to the UK Benchmarks Regulation (“UK BMR”).
On 5 March 2021 the Financial Conduct Authority (“FCA”) announced that LIBOR will cease to be representative of the underlying market that it seeks to measure. The FCA has made it clear that firms are expected to stop issuing new instruments referencing LIBOR that will mature after the end of 2021, and to actively transition existing contracts which will mature after the end of 2021, to alternative risk free rates. However it is anticipated that certain “tough legacy” contracts will be unable to transition effectively or at all. “Tough legacy contracts” are contracts that genuinely have no or inappropriate fallback rate alternatives and no realistic ability to be renegotiated or amended. The new powers seek to enable the FCA to reduce disruption to holders of such contracts.
Sections 8 to 21 and Schedule 5 of the Act will amend the UK BMR in the following ways:
Power to manage an orderly wind-down of a critical benchmark, such as LIBOR
The FCA’s new powers under the UK BMR will apply where the FCA designates a benchmark as a “critical” benchmark (which includes LIBOR) where that benchmark is no longer representative and will not be restored to representativeness. This designation gives the FCA powers with respect to that benchmark, including requiring that its continued provision be on the basis of a modified methodology. In the context of LIBOR, this modified methodology is sometimes referred to as a “synthetic” LIBOR. Firms will generally be prohibited from referencing any synthetic LIBOR unless an exemption is available for that particular legacy contract. The legacy contracts which will be subject to the exemption will be specified in a FCA Policy Statement following a pending consultation–Consultation Paper CP 21/15 – Benchmark Regulation: how we propose to use our powers over use of critical benchmarks–which commenced on 20 May 2021 and which is due to close on 17 June 2021. The FCA’s Policy Statement and feedback statement is scheduled to follow the consultation in Q3 2021.
Prohibition on the use of a specified benchmark
The FCA will have the power to prohibit some or all new use of a specified benchmark by supervised entities where the FCA considers it desirable to advance either or both of its objectives of ensuring an appropriate degree of protection for consumers and protecting and enhancing the integrity of the UK financial system.
Increased time over which the FCA can compel the administrator of a critical benchmark to continue its publication
The FCA can require the administrator of a critical benchmark to continue publishing a benchmark that it intends to cease publishing until (i) the provision of the benchmark has transitioned to a new administrator, (ii) the benchmark can cease to be provided in an orderly fashion or (iii) the benchmark is no longer critical. The maximum time that the FCA can compel the administrator to continue publication has been extended from five years to ten years. The effect of these changes is to provide for LIBOR’s availability for reference in tough legacy contracts that are exempted from the prohibition on use.
Final Thoughts
The amendments to the UK BMR follow similar legislative fixes enacted by the European Union and United States by amendments to the EU Benchmarks Regulation (“EU BMR”) and New York General Obligations Law (with US federal legislation pending). However, the UK legislative solution differs to those regimes in that they provide for a statutory replacement of discontinued rates with a designated risk-free rate. The UK changes are also significant in that they represent divergence from the EU BMR regime, which was incorporated into UK law following the UK’s departure from the EU on 31 December 2020.
The commencement date for these provisions has not yet been announced.
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