FCA Consultation on New Benchmark Powers Highlights Ongoing Discussions Regarding USD LIBOR
The Situation: On the same day that the ICE Benchmark Administration ("IBA") launched a consultation on its intention to cease publishing euro, sterling, Swiss franc, and yen LIBOR at year-end 2021, the UK Financial Conduct Authority ("FCA") separately set out how it plans to use its core, new benchmark-related powers to ensure a smooth LIBOR wind-down. This came in the immediate wake of Congressional testimony provided in the United States by Vice Chair Randal Quarles of the Governors of the Federal Reserve System (the "Fed") that suggested that the Fed is discussing a "mechanism" with the FCA that would effectively prolong the life of USD LIBOR.
The Result: These developments mark the start of the final phase of LIBOR wind-down. But new questions around the fate of USD LIBOR have emerged.
Looking Ahead: Neither the IBA nor the FCA consultations directly address USD LIBOR. However, their statements appear to confirm that transatlantic discussions relating to USD LIBOR are ongoing, and that there is an increase in the probability of different continuation outcomes for different LIBOR currencies. The Fed has suggested that more information about the contemplated "mechanism" would be made public in a "couple of months."
In previous publications, we have highlighted UK legislative proposals to give significant new powers for the FCA to manage an orderly transition away from the LIBOR benchmark (see "Latest Developments in Dealing With "Tough Legacy" IBOR Transition Contracts" and "UK Financial Services Bill Includes New Powers for FCA to Manage LIBOR Transition").
On November 18, 2020, the FCA launched two consultations ("Consultation on proposed policy with respect to the designation of benchmarks under new Article 23A" and "Consultation on proposed policy with respect to the exercise of the FCA's powers under new Article 23D") on the key powers it will assume (if the UK Financial Services Bill is passed in its current form), namely:
- Designating a critical benchmark (such as LIBOR) as unrepresentative—resulting in a prohibition on its use by UK supervised entities, as well as powers for the FCA to exempt certain existing uses of that benchmark from the general prohibition; and
- Requiring changes to a critical benchmark, including by amending its methodology and requiring continued publication for up to 10 years. In the case of LIBOR, this could allow a change so that LIBOR is no longer reliant on panel bank submissions.
At the same time, the IBA announced its own consultation on plans to cease publishing euro, sterling, Swiss franc, and yen LIBOR at the end of 2021.
This, in turn, led to a coordinated response from the International Swaps and Derivatives Association, Inc. ("ISDA") confirming that neither the FCA nor the IBA statements constitute an index cessation event under the IBOR Fallbacks Supplement, the ISDA 2020 IBOR Fallbacks Protocol, or trigger fallbacks under the 2018 ISDA Benchmarks Supplement or its protocol. The statements also are not expected to trigger any standard-form rate replacement clauses.
The FCA's stated policy framework is that it will use its key, new powers in only three circumstances:
- Where the critical benchmark is in regular use;
- Where there are contracts that cannot be practically amended without regulatory intervention; or
- Where it is necessary to protect consumers or UK market integrity.
The FCA has also given a preliminary indication that, if it were to apply this policy framework at year-end 2021 (on the basis of currently available information), then:
- It would not exercise its key powers in respect of euro and Swiss franc LIBOR at the time the relevant IBA panels are proposed to cease;
- It is likely to exercise its key powers to require a limited continuation of sterling LIBOR; and
- It is still considering the position in respect of yen LIBOR.
These developments mark the start of the final phase of LIBOR wind-down. Market participants do not need to take any specific action in response but should note the clear expectation that publication of euro and Swiss franc LIBOR will end in 2021. The position in relation to sterling, yen, and USD LIBOR is less clear, but some form of sterling LIBOR in particular seems likely to continue after year-end 2021 (but subject to limited use restrictions in the United Kingdom).
Issues to Watch
It is notable that neither the IBA nor the FCA consultations directly address USD LIBOR.
Recent Congressional testimony by Vice Chair for Supervision Quarles suggests the Fed is actively discussing with the FCA a "mechanism" to allow USD LIBOR legacy contracts to continue to be administered in accordance with their current terms, without the need for some number of them to be amended or otherwise transitioned to a risk-free rate before they expire. Other "hard tail" legacy contracts, Vice Chair Quarles explained, could be addressed separately through legislation, but only after the Fed has "more time to think about it" after pursuing the "mechanism" for commercial loans that could otherwise be amended.
As Vice Chair Quarles acknowledged, this "mechanism" would require significant cooperation by the FCA and other international regulators and will likely also require cooperation from the IBA. Details about the "mechanism" have not been made publicly available but are expected to emerge in a "couple of months," per Vice Chair Quarles.
The November 18 FCA and IBA publications appear to confirm that transatlantic discussions relating to USD LIBOR are ongoing. This increases the possibility of different continuation outcomes for different LIBOR currencies, adding to uncertainty and complexities for market participants to factor into their transition plans.
It also remains to be seen how the FCA's proposed policy framework outlined above can be made to work with the Fed's "mechanism," particularly given the FCA's stated intention not to use its new powers to address amendable contracts.
Two Key Takeaways
- The FCA and IBA have separately published consultations that mark the start of the final phase of LIBOR wind-down. Market participants should continue to factor these developments into their transition planning.
- Transatlantic discussions relating to USD LIBOR are ongoing, increasing the possibility of different outcomes for different LIBOR currencies. Financial institutions and market participants should continue to prepare to transition away from USD LIBOR until there is clarity and certainty that the Fed, FCA, IBA, and other relevant parties can align on any "mechanism" that might impact the transition timeline, particularly given the FCA's stated policy framework related to amendable legacy contracts.