UK’s FCA Decision on Synthetic US Dollar LIBOR

Background

Based on feedback to its Consultation of November 2022 on ‘synthetic’ US dollar LIBOR, the United Kingdom’s Financial Conduct Authority (the “FCA”) announced on 3 April 2023 (the “FCA LIBOR Announcement”) its decision to require LIBOR’s administrator, ICE Benchmark Administration Limited (“IBA”), to continue the publication of the 1-, 3- and 6-month US dollar LIBOR settings for a short period after 30 June 2023 (the date on which US dollar LIBOR will cease to be published by the IBA on a “representative” basis), using an unrepresentative ‘synthetic’ methodology for the calculation of US dollar LIBOR (“Synthetic USD LIBOR”). 

The FCA LIBOR Announcement also confirms that the end of Synthetic sterling LIBOR is nigh, with the last synthetic Sterling LIBOR setting (the 3-month synthetic Sterling LIBOR setting) expected to cease to be published at the end of March 2024. 

The FCA LIBOR Announcement confirmed that the FCA will, pursuant to the UK Benchmarks Regulation,¹ take the following actions by means of notices to be published by 1 July 2023:

• designate US dollar LIBOR as permanently unrepresentative of the market that it is intended to measure and as a critical benchmark that is, accordingly, in the process of being wound down;
• permit use of US dollar LIBOR for legacy contracts for all parties (including by supervised entities) other than for Cleared Derivatives (within the meaning of the notices);
• sustain US dollar LIBOR for a limited period (expected, at this time, to be the end of September 2024); and
• impose a requirement on the IBA to change the methodology for determining US dollar LIBOR to the Synthetic USD LIBOR rate.

The Synthetic USD LIBOR Rate

Synthetic US LIBOR will, as announced, be determined by reference to the forward-looking term SOFR reference rate provided by CME Group Benchmark Administration (the “CME Term SOFR Reference Rate”) plus the respective ISDA fixed spread adjustment for the relevant LIBOR tenor (which may be a positive or negative value or zero) that is published for the purposes of the ISDA 2020 IBOR Fallbacks Protocol² and the ISDA IBOR Fallbacks Supplement.³

The FCA considers that such methodology, based on the relevant CME Term SOFR Reference Rate and the corresponding ISDA spread adjustment, will:

• provide certainty on the interest payments due to be calculated, made or received on dates specified in legacy contracts in a manner similar to how those legacy contracts would have operated under a continued, representative US dollar LIBOR and minimise the need for parties to such contracts to make consequential changes to their terms; and

• align with formal recommendations of the Alternative Reference Rates Committee (the “ARRC”) to use the term SOFR Reference Rates produced by CME Group Benchmark Administration (“CME”) as an alternative reference rate for US dollar LIBOR in certain cases (including in legacy contracts that have adopted the ARRC’s recommended fallback language for US dollar LIBOR).⁴ On this aspect, the FCA has also noted that the United States Federal Reserve Board published its final rules to implement the United States Adjustable Interest Rate (LIBOR) Act (the “US LIBOR Act”) in December 2022 and has provided for the use of the CME Term SOFR Reference Rate as the benchmark replacement rate for LIBOR for non-derivative products.

Application of the Synthetic USD LIBOR

Mindful that the United States has made provision under the US LIBOR Act for transitioning contracts governed by US law that reference a US dollar LIBOR reference rate away from US dollar LIBOR, the FCA has duly considered the interaction between the US LIBOR Act and the exercise of its powers under the UK Benchmarks Regulation. 

In particular, the FCA has considered whether it needed to prohibit legacy contracts governed by US law from using Synthetic US dollar LIBOR.

Based on discussions with the US regulators, the FCA has concluded that:

• the only contracts governed by US law that may potentially use the US dollar LIBOR after 30 June 2023 are those without workable fallback provisions that do not, consequently, fall within the scope of the US LIBOR Act—so there should be no direct legal conflict between the operation of the US LIBOR Act and the exercise of the FCA’s powers under the UK Benchmarks Regulation; and

• contracts governed by US law that do not contain workable fallback provisions are a relatively small subset of contracts and that few such contracts would, in any case, fall within the scope of the UK Benchmarks Regulation and be impacted by any prohibition imposed by the FCA (and determining whether any such contract was within the scope of the UK Benchmarks Regulation would increase complexity for market participants and create legal uncertainty and litigation risk).

As a result, the FCA has chosen not to prohibit the use of Synthetic USD LIBOR by parties to legacy contracts that are not governed by English law (including, in particular, legacy contracts governed by US laws).

¹ Regulation (EU) 2016/1011 (as amended) as it forms part of domestic law in the United Kingdom from the end of the Brexit transition period (11pm on 31 December 2020)

² https://assets.isda.org/media/3062e7b4/08268161-pdf/

³ https://assets.isda.org/media/3062e7b4/23aa1658-pdf/

⁴ ARRC-Press-Release-Summary-of-ARRC-Recommended-Fallbacks.pdf (newyorkfed.org).