The UK Financial Services Act 2021 amended the Benchmarks Regulation1 (the “BMR”) to enable the FCA to manage a situation in which a critical benchmark has become or is at risk of becoming unrepresentative and where it may be impractical or undesirable to restore its representativeness. In particular, the FCA may designate a critical benchmark (such as LIBOR) that it determines is unrepresentative or is at risk of becoming unrepresentative under Article 23A, with the result that its use (as defined in the BMR) by supervised entities is prohibited by virtue of Article 23B, except where legacy use is permitted by the FCA under Article 23C. The FCA may instruct the benchmark’s administrator to publish the Article 23A benchmark under a changed (“synthetic”) methodology (here, “synthetic LIBOR”), which may no longer be representative of the underlying market or economic reality that the benchmark sought to measure, using powers under Article 23D, in order to facilitate an orderly cessation. The FCA is able, under Article 21(3) to compel the administrator of a benchmark to continue publishing it in this form for up to 10 years. The FCA will exercise these powers where it considers it necessary to further its objectives of consumer protection and preserving market integrity.
As part of the preparation for LIBOR transition, in February 2021 HM Treasury issued a consultation entitled “Supporting the wind-down of critical benchmarks”2 (the “Consultation”). While stressing the need for firms to continue to prioritise active transition away from LIBOR to alternative benchmarks, the Consultation sought views on whether a legal safe harbour could be a helpful supplement to the provisions which were inserted into the BMR by the Financial Services Act 20213. After considering the responses to the Consultation the Government confirmed that it would bring forward legislation which would “seek to reduce disruption that might arise from LIBOR transition with regard to the potential risk of contractual uncertainty and disputes in respect of contracts that have been unable to transition from LIBOR to another benchmark (so-called “tough legacy” contracts), where the FCA has exercised the powers given to it in the Financial Services Act”4.
On 8 September 2021, the Critical Benchmarks (References and Administrators’ Liability) Bill (the “Bill”) was introduced into the House of Lords. It operates in a similar way to the Financial Services Act 2021 (i.e., by inserting amendments into the BMR):
- Clause 1 of the Bill inserts two new Articles 23FA and 23FB into the BMR, which are intended to provide legal certainty as to how references to benchmarks in contracts and other arrangements should be interpreted once the FCA has designated a benchmark under Article 23A5; and
- Clause 2 of the Bill inserts a new Article 23FC into the BMR, which addresses the liability of administrators of Article 23A benchmarks.
It is worth emphasising that the safe harbour provisions in the Bill only apply to the transition from LIBOR to synthetic LIBOR (i.e., to the situation where the FCA mandates a change from LIBOR to synthetic LIBOR, which, in the case of financial contracts, will apply to “tough legacy” contracts6). They do not apply to the transition from LIBOR to an alternative reference rate (“ARR”). The UK approach is therefore different to the approach of the New York State Legislature, which has provided for a comprehensive litigation safe harbour for transition from LIBOR to the approved ARR.
In summary, the Bill provides as follows:
- Contractual continuity: Clause 1 of the Bill provides that reference to a benchmark in a contract is treated as including the same benchmark when it becomes an Article 23A benchmark and when a new (“synthetic”) methodology is imposed under Article 23D of the BMR. The Bill also provides that the contract is to be treated as having always provided for the reference to have this meaning. In the case of LIBOR, therefore, the impact of Clause 1 will be to provide for contractual continuity when LIBOR changes to synthetic LIBOR – references in the contract to LIBOR will be read as references to synthetic LIBOR, and parties will be taken to have always agreed that this should be the case.
- No interference with fallback provisions: Clause 1 provides that these continuity provisions do not cut across or interfere with contractual fallback provisions that would allow the contract to transition away from referencing LIBOR to an ARR.
- No creation of new claims: In order to prevent claims that there had been some form of pre-contractual representation or advice (e.g. as to the way in which LIBOR would be calculated) which – in light of the change to synthetic LIBOR – has now been breached, Clause 1 provides that nothing in the Bill creates any right, obligation or liability in respect of acts or omissions relevant to the formation of the contract which took place prior to the benchmark becoming an Article 23A benchmark. Similarly, nothing in the Bill will extinguish or otherwise affect any cause of action which arose before the benchmark became an Article 23A benchmark, but this may be taken into account when determining any loss or damage.
- Benchmark administrator: Clause 2 provides a limited immunity for a benchmark administrator who is directed by the FCA to apply a specific methodology to the calculation of synthetic LIBOR: the administrator of an Article 23A benchmark and its officers and employees will not be liable in damages for action or inaction required by a notice issued by FCA under Art 23D or for publishing the benchmark as it exists as a result of such action or inaction: i.e., for complying with their statutory duty to calculate/publish synthetic LIBOR as required by the FCA. The protection does not, however, extend to any discretion exercised by the administrator in its production of the benchmark or as to the time or manner of publication.
Although the Bill does not introduce an express litigation safe harbour like that provided by the New York legislation, its provisions do assist with addressing the risk of potential claims for breach of contract and frustration following a transition to synthetic LIBOR:
- Except where the contract/arrangement expressly provides to the contrary, sums due under the contract/arrangement are to be calculated by reference to synthetic LIBOR: this should deter a party from claiming that this is not what the contract provides for, and thus from bringing a breach of contract claim.
- By providing, on a formally retrospective basis, that the contract has always provided for the reference to LIBOR to have this meaning, this will deter parties from claiming a contract is frustrated or has been materially changed because the benchmark in its designated (synthetic) form is different from what the parties contemplated when they entered into the contract.
Many of the published responses to the Consultation stressed the desirability of enacting a safe harbour which was as comprehensive as possible: which would not only provide for contractual continuity, but would also provide for a safe harbour against any litigation which might be brought as a result of the LIBOR transition, whether that was a transition to a new ARR or a transition to synthetic LIBOR. The Bill does not cover transition to a new ARR, so the current risks of litigation relating to such a transition remain. In the absence of a comprehensive, express, prohibition on litigation, there is potentially still scope for some claims to be brought, including in relation to misselling. However, the introduction of a limited safe harbour is certainly to be welcomed.
The FCA’s consultation on legacy use of synthetic LIBOR was published on 29 September 2021, with responses due by 20 October 2021. The FCA is proposing (at least for the duration of 2022) to permit legacy use of 1m, 3m and 6m synthetic sterling and Japanese yen LIBOR in all contracts except cleared derivatives, and has said that it will confirm its final decision on permitted legacy use as soon as practicable after the consultation closes. On the same date, the FCA confirmed the methodology it will require LIBOR’s administrator to use for calculating those synthetic rates.
If you have any questions about the Bill’s safe harbour provisions, or about LIBOR transition in general, please contact the author or any of your usual Hogan Lovells advisors.
Authored by Arwen Handley