UK Benchmarks Regulation and tough legacy Financial Services Act 2021 enacted

On 29 April 2021, the Financial Services Act 2021 (the Act) received Royal Assent. The Act is an omnibus piece of legislation that amends several elements of the UK's financial services legislative framework, including the UK PRIIPs Regulation and the UK Benchmarks Regulation (the UK BMR). The text of the relevant sections of the Act does not deviate from that proposed in the original Financial Services Bill.

Background

On 5 March 2021, the FCA announced that the majority of LIBOR rates will cease, or cease to be representative of their underlying market, on 31 December 2021, although certain USD LIBOR rates will continue on a representative basis until 30 June 2023. Amongst other things, the Act amends the UK BMR to address the issue of "tough legacy" contracts: LIBOR-based contracts that (i) will mature after the applicable cessation date, (ii) contain no fallback provisions or inappropriate fallback provisions, and (iii) have no realistic prospect of early transition to an alternative rate.

Article 23A benchmarks and synthetic LIBOR

Under the amended UK BMR, the FCA is able to designate a critical benchmark – including LIBOR or any particular LIBOR currency/tenor combination - which has become or is at risk of becoming unrepresentative, an "Article 23A benchmark" (after the applicable new UK BMR provision). Such designation gives the FCA broad powers in respect of that benchmark, including the power to compel its continued provision on the basis of a modified methodology. In the case of LIBOR, this would give rise to so-called "synthetic" or "transition" LIBOR¹.

UK supervised entities are generally prohibited from using an Article 23A benchmark. However, an exemption is available for certain types of legacy contracts, in respect of which UK supervised entities will be able to continue to use the benchmark in its modified form. The Act does not specify the circumstances in which the exemption will apply, leaving this to be detailed in a future FCA Policy Statement following market consultation (see below).

Prohibition on new use of outgoing benchmarks

The FCA also now has the power to prohibit new use of benchmarks which are due to be discontinued (outgoing benchmarks). It is possible that the FCA will use this power to prohibit new use of USD LIBOR by UK supervised entities after the end of 2021, in line with similar guidance applicable to U.S. banks.

Future FCA consultations

The FCA intends to consult throughout Q2 2021 on (i) its power to prohibit the use of an outgoing benchmark, (ii) the contract types that fall into the "tough legacy" category for exemption from the general prohibition discussed above, and (iii) the possible exercise of its power to compel ICE Benchmark Administration, as LIBOR's administrator, to provide a synthetic version of one-month, three-month and six-month GBP and JPY LIBOR after 31 December 2021, for use in exempted contracts. Related FCA Policy Statements are also expected to be published in due course.

Other legislative solutions

The FCA's approach to tough legacy contracts differs from that of the EU and the U.S., both of which have recently implemented related legislative solutions, in the form of amendments to the EU Benchmarks Regulation and the New York General Obligations Law, respectively. Corresponding federal legislation is also expected in the U.S. in due course. These regimes contemplate an automatic, statutory, replacement of discontinued rates with adjusted risk-free rates.

Extension of transitional provisions

Finally, the Act amends the UK BMR to extend the application of the third-country benchmarks regime until 31 December 2025. This means that, under the amended UK BMR, UK supervised entities will be able to use benchmarks provided by third-country administrators until such date, irrespective of whether they are included on the FCA's third-country benchmark register.

It will be helpful to market participants to know that these amendments to the UK BMR are now confirmed, particularly the extension of the transitional provisions. However, critical details of the "tough legacy" piece are still missing, leaving many entities unable to fully complete their transition analysis at this stage.

1. In an earlier consultation the FCA indicated that any synthetic rate would likely be based on the relevant forward-looking term rate plus the applicable spread adjustment calculated in accordance with the ISDA methodology used in conjunction with its newly-agreed IBOR fallback provisions.