The UK Government passed the Financial Services Act 2021 (the “FS Act 2021”) on 29 April 2021, which amended the UK Benchmarks Regulation ((EU) 2016/1011) (the “UK BMR”), to provide the UK Financial Conduct Authority (the “FCA“) with new and enhanced powers to oversee the orderly wind-down of critical benchmarks. In particular, the legislation addresses the risk that LIBOR cessation poses to “tough legacy contracts” (i.e., contracts that genuinely have no or inadequate fallback rate alternatives and no realistic ability to be renegotiated or amended). The Critical Benchmarks (References and Administrators’ Liability) Bill (the “Bill”) has been drafted to address these risks.

The Financial Services Act 2021

The UK BMR, as modified by the FS Act 2021, grants the FCA new powers to “designate” a critical benchmark under Article 23A where it determines that the benchmark no longer accurately represents, or is at risk of no longer accurately representing, the underlying market it seeks to measure, and where the “representativeness” of the benchmark cannot or should not be maintained or restored.[1] Where the FCA “designates” a critical benchmark under Article 23A, the use of that benchmark is prohibited once the designation comes into force. However, the FCA then has the power to allow certain exempted tough legacy contracts that referenced the designated benchmark to continue to use the benchmark after its designation. In the case of LIBOR, this would allow the FCA to compel the continued publication of LIBOR using a revised methodology, known as “synthetic LIBOR,” and permit certain legacy contracts to continue to use the benchmark in its synthetic form.

The FCA is in the process of consulting on which legacy contracts should be exempted from the prohibition on the use of LIBOR and will state which contracts are exempt in future policy.

Contractual uncertainty and dispute

Following publication of the Bill for the FS Act 2021, HM Treasury received feedback that further action is necessary to protect users of a benchmark where the FCA exercises its powers, including in cases where parties may be uncertain of, or contest, the continued application of LIBOR to their contract after the FCA has exercised its powers to require continued publication of LIBOR using a synthetic methodology. Consequently, the Government has determined that it is appropriate to bring forward further legislation to address the issues identified.

Supporting the orderly wind-down of a critical benchmark under Article 23A of the UK BMR

The Bill has been drafted to address market concerns and on 8 September 2021 the Bill received its first reading in the House of Lords. As with the FS Act 2021, any supplemental legislative solutions and powers granted under the Bill will apply to English law governed contracts only. The proposed powers in the Bill that will concern most market participants is the provision for legal certainty as to how contractual references to a critical benchmark should be interpreted where the FCA exercises its powers under the UK BMR. This proposed provision will ensure that where the FCA exercises its powers, parties to tough legacy contracts will be able to continue to apply LIBOR to their contracts in its modified form with confidence that doing so will not give rise to claims such as breach of contract or frustration.

In the case of LIBOR, for example, the Bill aims to provide certainty that contractual references to LIBOR should continue to be treated as references to that benchmark where the FCA has directed a change in how LIBOR is calculated. This provides parties with clarity that, unless the contract provides otherwise, an Article 23A designation of the benchmark under the UK BMR does not in itself provide grounds for contracting parties to argue that use of the synthetic benchmark amounts to a breach of contract, material change or frustration of the contract. The Bill also makes clear that in respect of an Article 23A benchmark, where a contract or other arrangement includes a fallback clause to operate by reference to a benchmark other than the stated benchmark, the new provisions do not prevent or affect the operation of that fallback clause.

Comment

The Bill appears to recognise that there may be shortcomings in legislative solutions to LIBOR cessation. Even the creation of a synthetic LIBOR might still leave it open to imaginative counterparties to claim breach of contract, material change or frustration. This concern is particularly acute with respect to contracts involving counterparties in third country jurisdictions and the potential difficulties of enforcing legislative solutions against all applicable counterparties. The Bill should nonetheless provide some additional certainty and minimise disruption for parties to contracts that are considered to be incapable of being transitioned to alternative rates. However, time is short and this comfort will be limited because the FCA is yet to release its final policy on which contracts will ultimately be permitted to rely on a continued publication of LIBOR. This is a pressing issue as the FCA has repeatedly emphasised that market participants should transition to alternative rates before most LIBOR settings are discontinued at the end of 2021.

[1] The FCA made such a designation with respect to 1, 3 and 6-month GBP LIBOR and 1, 3 and 6-month JPY LIBOR settings on 29 September 2021.