LIBOR and the FCA's powers under the UK Benchmarks Regulation: questions and answers

It is important that market participants understand how their contract terms interact with the winding down of a critical benchmark. Firms should seek their own legal advice on this.

If a contract contains provisions that will move the contract away from LIBOR as a result of unrepresentativeness or permanent unrepresentativeness (a “pre-cessation” trigger), this should mean that the contract moves away from the relevant sterling or Japanese yen LIBOR setting at the time, or just before, it becomes unrepresentative.

Our decision on which contracts are permitted to use synthetic LIBOR will therefore not be relevant to these contracts, as they will automatically convert to the replacement benchmark set out in their fallback arrangements.

It is important that market participants understand how their contract terms interact with the winding down of a critical benchmark. Firms should seek their own legal advice on this.

Broadly speaking, in contracts referencing 1, 3 or 6m sterling or yen LIBOR that only include fallbacks which operate when a benchmark ceases permanently, these fallbacks are not likely to be triggered while these LIBOR settings continue to be published using a synthetic methodology for a wind-down period (although this will depend on the wording of individual contracts). Rather, these fallbacks are likely to operate only when the relevant LIBOR settings cease to be published in any form.

We have encouraged market participants to consider including contractual terms that operate not only when LIBOR ceases but when it becomes permanently unrepresentative (i.e. pre-cessation triggers). This is a legal requirement for those subject to the BMR (see Article 28(2) and Q&A 8.1[1]). We have also made clear that where parties can practicably agree to convert their contracts on fair terms they should do so.

Firms should be amending their contracts wherever practicable to remove reliance on LIBOR regardless of our decision to require publication of certain synthetic LIBOR settings. Synthetic LIBOR is not a permanent solution.

We expect firms to take account of the information available to them at the time of transition with a view to treating their customers fairly. 

It is ultimately up to firms to decide which replacement rate to use (whether that be term SONIA, compounded SONIA, or Bank Rate, for example), providing that customers are treated fairly and the selected replacement rate meets customers’ needs. Firms should also take account of relevant industry guidelines and recommendations, for example around use of term risk-free rates.

Our LIBOR conduct Q&A[2] recognises the industry consensus that has been established around transition to SONIA, and also sets out a path to achieving a fair transition when using Bank Rate (once LIBOR ceases or become unrepresentative). It also sets out considerations for firms dealing with customers who are less familiar with interest rate markets.

We made clear i[3]n 2017 that market participants need to prepare for a future without LIBOR, and transition to alternative reference rates. This has always been a market-led initiative. In the UK, these efforts are being led by the industry Working Group on Sterling Risk-Free Reference Rates[4]. As the transition progressed, market participants highlighted the need[5] for a solution for ‘tough legacy’ contracts that cannot transition. The Government recognised that legislative steps could help these contracts and have delivered legislation to help. The package of measures[6] we announced on 29th September recognise that there is a portion of sterling and yen legacy contracts that it will not be practicable to convert by year-end. We are using our new powers to provide a “bridging” solution for those contracts.

The steps that have allowed us to get here are described below. 

• HMT providing the necessary legislative framework: This was done by amending and strengthening[7] the UK’s existing regulatory framework for benchmarks, to ensure the FCA has the appropriate regulatory powers to manage the wind-down of LIBOR, in line with its market integrity and consumer protection objectives.
• FCA and market working together to determine a suitable “bridging” rate and how it could apply: Once the amendments to the BMR were confirmed, we worked with the market through a consultation process to determine how we would use our new powers to implement synthetic LIBOR rates. This has involved a two-stage process – first developing a policy approach for the use of some of our new powers, and secondly applying this policy to LIBOR.  
• Industry reducing the existing population of legacy contracts as far as possible through active transition and adoption of robust fallbacks: The extensive work undertaken by industry to transition contracts and adopt robust fallbacks has made us more confident in proposing wide permitted usage of synthetic LIBOR. For example, without the significant uptake of ISDA’s IBOR Fallbacks Protocol, it is unlikely we would have been comfortable proposing that uncleared derivatives are permitted to use synthetic sterling and yen LIBOR. Wide use of a benchmark based on term RFRs in the derivatives market would have posed a risk to the robustness of those rates. But it is now clear that by far the largest part of the derivatives markets will be transitioned to compounded rates.

In our proposals, we have taken on board market feedback on the difficulty of distinguishing with clarity and certainty between contracts that can be amended before year-end and those that can’t.

Our expectations around the need to remove reliance on LIBOR has not changed. Continued use of synthetic LIBOR will allow some contracts to reach their natural maturity and roll-off. However, in most cases, it should be viewed as providing a further period to complete transition of legacy contracts, rather than an alternative. Synthetic LIBOR is not a permanent solution. The availability of synthetic LIBOR rates will be subject to annual review. Ongoing availability to synthetic LIBOR beyond 2022 cannot be assured.

We have also said we may revisit the proposed permission for legacy contracts to use synthetic LIBOR in future, if we do not see sufficient progress by firms to remove reliance on synthetic LIBOR where it is otherwise desirable to advance our consumer protection and/or integrity objectives. 

Our ability to permit (or not permit) legacy use of synthetic LIBOR only affects entities and contracts that are within scope of the BMR. Firms will need to get their own legal advice as to whether they fall within the BMR definition of a UK supervised entity and their contract is within scope of the BMR.

If a contract is out of scope of the BMR, it will not be affected by our ‘legacy use’ decision. Where a contract references 1, 3 or 6m sterling or yen LIBOR, firms will need to take their own legal advice about how synthetic LIBOR will interact with their contract provisions. However in broad terms (and subject to how the contract is drafted), the outcome for contracts that haven't been amended and do not include provisions that move them away from LIBOR at or before the end of the year, is that they would be able to continue to use synthetic LIBOR.

While the underlying methodology for the 6 sterling and yen LIBOR settings are expected to change from the start of 2022, LIBOR’s administrator will be required to continue publishing these settings at the scheduled publication time and for all applicable London business days as is currently the case for panel-bank LIBOR. We do not expect the changes in the underlying methodology to affect how LIBOR should continue to be displayed on the relevant screen pages.

We welcome communication from Bloomberg and Refinitiv that all continuing LIBOR settings (including the 6 settings under a ‘synthetic’ methodology) will continue to be available on the same screens from the start of 2022 as they will at the end of 2021. We also welcome confirmation from IBA that it expects to make all continuing LIBOR settings (including the 6 settings under a ‘synthetic’ methodology) available to licensees through existing IBA licensee distribution services, as is the case for all current LIBOR settings.

The Government has also introduced further legislation[8] to ensure that a ‘synthetic’ LIBOR is read as LIBOR within existing contracts. This legislation applies to a broader scope of contracts than those within the BMR.

However, even if a contract is able to use synthetic LIBOR, and whether or not a contract is inside or outside the BMR’s scope, our supervisory expectation remains the same. Firms should amend their contracts to remove reliance on LIBOR and use appropriate alternatives wherever practicable, across all asset classes. This will remain the case after end-2021, given synthetic LIBOR is not a permanent solution. We also continue to expect customers to be treated fairly.

New use of synthetic LIBOR is prohibited under the BMR, but we have also been clear[9] that synthetic LIBOR is not for use in new contracts more broadly. This is supported by the FSB’s global transition roadmap[10], which says that all new business should be conducted using alternative rates by end-2021.

No. The availability of synthetic LIBOR rates will be subject to annual review, so active transition will provide more certainty for the future. Ongoing availability of synthetic LIBOR beyond 2022 cannot be assured.

In many cases there will also be advantages to moving to use of compounded risk-free rates at an earlier stage. It has the most robust underlying markets, and as the new market standard for most products, it will benefit from the greatest liquidity in hedging products.

The two-stage consultation process for our ‘use’ powers was intended to give market participants the opportunity to engage on these important issues. Firstly, we have consulted on the policy framework (which could be relevant to any critical benchmark in future), and secondly on how we apply this framework to LIBOR (i.e. our proposed decisions in relation to the use of LIBOR).

In any case, synthetic LIBOR will be time limited and should be viewed as providing a further 'bridging' period to complete transition of legacy contracts, rather than an alternative. We encourage market participants to continue active transition away from LIBOR wherever practicable, and not to delay their plans by waiting for our final decisions on ‘use’ of synthetic LIBOR. Agreeing amendments between counterparties is the best way for parties to have certainty and control over their contractual terms going forward.

In relation to our decision to restrict new use of US dollar LIBOR after year-end, firms should already be working towards this deadline across all asset classes in line with existing FCA / PRA supervisory expectations[11].

As the home jurisdiction of LIBOR’s administrator, the UK has a distinct role to play in minimising global financial stability risks and disruption to financial systems from the wind-down of LIBOR. We expect that the change of methodology imposed by the FCA through LIBOR’s administrator should flow through to global users of existing LIBOR contracts continuing to reference the rate. This, however, would be subject to other jurisdictions’ legislative frameworks that may deal with legacy contracts.

EU/US/UK authorities all agree that contractual governing law clauses should prevail. We do not and would not seek to override legislative solutions applying in respect of the contractual governing law.  

We are aware of the benefits of alignment in legislative approaches (i.e. where legislative solutions point to the same replacement rate), notably in the wholesale space. That said, there may be cases where some differentiation in approach is warranted. Such differentiation may be a conscious choice where there are clear advantages to deviate for a particular product in a particular jurisdiction. By aligning outcomes (i.e. selecting the same replacement rate via our respective legislation), we should be able to solve most concerns about international coordination.

We continue to work closely with our international counterparts both bilaterally and through the Financial Stability Board’s Official Sector Steering Group[12] (OSSG) and IOSCO. While the tools available for LIBOR transition may differ across jurisdiction (and may include supervisory, regulatory or legislative approaches), we are all conscious of the benefits of alignment.

As set out in our 5 March announcements[13], the 1 week and 2 month US dollar LIBOR settings will cease at end 2021. The remaining US dollar LIBOR settings will continue on a representative, ‘panel bank’ basis, until mid-2023.

We will continue considering the case for using our powers to require continued publication on a changed methodology for the 1, 3 and 6m US dollar LIBOR settings, when the US dollar LIBOR panels ends in June 2023, but market participants should not rely on our doing so. The decisions to require publication of some sterling and Japanese yen LIBOR settings on a synthetic basis (and also our proposed decisions on who can use them) are not determinative of any future decisions in respect of US dollar LIBOR from end-June 2023.

The 29 September publications include a consultation[14] on our proposed decision to prohibit most new use of US dollar LIBOR after end-2021, in line with US guidance[15] (which the FSB[16] and IOSCO[17] have also recommended apply to all global market participants). We published a Notice confirming this decision on 16 November.

Requiring a further year of publication of 1, 3 and 6m Japanese yen LIBOR on a ‘synthetic’ basis is intended to help to facilitate an orderly wind-down and protect market integrity by allowing more time for legacy transition to be completed. Our intention not to renew this requirement at end-2022 reflects our policy intention to intervene for as short a time as is appropriate to assure an orderly wind-down of the critical benchmark, in line with our consumer protection and market integrity objectives. We have also taken into account evidence and views from market participants and our counterpart global authorities. 

We are required to review our decision to compel continued publication of the 3 sterling LIBOR settings annually. Its continued availability cannot be assured beyond end 2022. Our policy intention is to intervene for as short a time as is appropriate to assure an orderly wind down. We anticipate needing to review, and potentially renew, our requirement to publish synthetic sterling LIBOR.

However, its ongoing availability will depend on a number of factors, including market participants’ transition progress, which we will continue to monitor closely.

Our power to direct a change in methodology is only available where a benchmark has become unrepresentative and its representativeness will not be restored (i.e. it has been designated as an ‘Article 23A benchmark’).

Directing a change in methodology is intended to stabilise the rate for a time limited wind-down period; not restore representativeness for the rate to continue indefinitely.

We have chosen the synthetic rate to provide a reasonable and fair approximation of what panel bank LIBOR might have been in the future (if it wasn’t ceasing). However, it would not be representative of the underlying market and economic reality that LIBOR was intended to measure, e.g., it would reflect the fluctuating term credit premium embedded in LIBOR only in a static rather than dynamic way.

This is a result of the way the legislation works. We can only require a change by LIBOR’s administrator to LIBOR’s methodology under Article 23D, once the relevant settings have actually become permanently unrepresentative ‘Article 23A’ benchmarks (i.e. when the designation takes effect). For the relevant sterling and yen LIBOR settings, this will happen at 00:01 on 1 January 2022, from which point the panel banks will no longer contribute submissions. We expect our final legacy use decision to come into effect on the same day.

The draft Article 23D Notice[18] confirms our final decision and we have published it to provide early clarity to market participants. We will issue the notice in substantially the same form and serve it to LIBOR’s administrator on 1 January 2022 and the requirements will become effective immediately. We fully expect the final form of the notice to mirror the drafts already provided.