Legislating for the LIBOR transition: synthetic LIBOR for tough legacy contracts
With less than four months to go before the FCA turns off the supply of daily LIBOR (in its well-used form) for most of the 35 currency-tenor settings (see The coming end of LIBOR), the UK Government has introduced the Critical Benchmarks (References and Administrators’ Liability) Bill to the House of Lords.
When enacted, the Bill will amend the UK’s Benchmarks Regulation – supporting the new and enhanced powers given to the FCA (via the Financial Services Act 2021’s previous amendments to the Benchmarks Regulation) to oversee the orderly wind-down of LIBOR and ensure contractual continuity for ‘tough legacy’ contracts. These are contracts using LIBOR that are proving too difficult to move to robust alternative rates (we touched on some of the challenges in Beyond LIBOR: transatlantic divergence in loan markets).
The global effort to transition from LIBOR has evolved over time to recognise that a legislative solution might be needed to accommodate these too difficult to amend contracts. Whilst it is still to be finalised, the UK’s proposed solution – which has some potential to overlap with LIBOR-related legislation in the US and EU – is to mandate the publication of ‘synthetic’ LIBOR for certain currency-tenor settings after they cease to be published in current form. This is contemplated for 1, 3 and 6 month GBP LIBOR and JPY LIBOR from the beginning of 2022 and 1, 3 and 6 month USD LIBOR from the beginning of July 2023. Each synthetic GBP LIBOR and JPY LIBOR setting is to be calculated as the sum of: (a) a (now published) term reference rate derived from the chosen Risk-free Rate (RFR) for each currency (SONIA for GBP; TONAR for JPY); and (b) the fixed credit adjustment spread (CAS) for that setting published by Bloomberg for the purposes of ISDA’s fallbacks for LIBOR-referencing derivatives. Any synthetic USD LIBOR will be developed closer to when it is to be implemented.
The Bill is intended to provide certainty as to how contractual references to LIBOR (however expressed) should be interpreted where the FCA mandates that a synthetic version be published for the relevant setting. It should deter (and offer a defence against) claims for breach or frustration of contract where synthetic LIBOR is legitimately relied on. Whilst some immediate questions have been raised as to the scope of the Bill (citing the protection from claims offered by the broader ‘safe harbour’ found in US legislation), we imagine the Bill will be widely welcomed.
Even in its current form, the Bill is a noteworthy intervention in private contracts. As we have noted before in other contexts (Blunting the effect of 'ipso facto clauses' – a reasonable interference with freedom of contract?), English lawyers are naturally suspicious of this. However, such intervention is consistent with the approach taken to ensuring continuity of obligations when the Euro replaced national currencies two decades ago. And on the long and winding road of LIBOR transition, this legislative solution would seem necessary to smooth the path and avoid a flood of contractual disputes in the UK.
The Bill will support the effective operation of the powers granted to the Financial Conduct Authority (FCA) under the Financial Services Act 2021 to oversee the wind-down of a critical benchmark. In particular, this Bill will provide legal certainty as to how contractual references to a critical benchmark should be treated where the FCA exercises powers under the Benchmarks Regulation (BMR) to provide for the continuity of an unrepresentative critical benchmark.
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