FCA launches tough legacy consultation and designates Article 23A benchmarks

On 29 September 2021, the FCA undertook a number of important actions relating to the UK's framework for the orderly wind-down of LIBOR under the UK Benchmarks Regulation (UK BMR). In particular, the FCA:

• launched its highly-anticipated "tough legacy" consultation, proposing (i) broad tough legacy parameters and (ii) a restriction on the use of USD LIBOR by supervised entities after 2021;

• designated certain LIBOR rates as Article 23A benchmarks under the UK BMR; and

• compelled ICE Benchmark Administration to continue to produce the designated rates on a synthetic basis for at least twelve months.

Each of these developments is summarised below.

Tough legacy consultation

Background - Article 23A and synthetic LIBOR

Under the UK BMR, the FCA has broad powers with regard to the treatment of critical benchmarks such as LIBOR. These include the ability to designate LIBOR, or individual tenor/currency LIBOR rates, as "Article 23A benchmarks" if the benchmark has become or is at risk of becoming unrepresentative.

Once a rate has been designated an Article 23A benchmark, its use¹ by UK BMR "supervised entities" is restricted, save in certain "tough legacy" contracts. The FCA is also able to force a change in methodology of any designated LIBOR rate, to produce what is commonly referred to as "synthetic LIBOR" (see Synthetic LIBOR below). This framework has been in place for some time but until now the parameters of the tough legacy regime were unclear.

Broad tough legacy use

In the consultation, the FCA proposes a helpfully broad definition of "tough legacy", suggesting that UK supervised entities should be permitted to continue to use synthetic LIBOR in all UK BMR in-scope contracts ² except for cleared derivatives until at least the end of 2022. Thereafter, use may be restricted if the FCA considers it necessary to ensure an orderly transition away from LIBOR, and if transition efforts wane as a result of what is intended to be a short-term reprieve. In particular, the FCA does not consider that all derivatives used to hedge cash products referencing synthetic LIBOR need to reference synthetic LIBOR themselves, suggesting that basis swaps could be used to mitigate divergences, or that the loan itself could be transitioned.

Notwithstanding the FCA's proposal to apply a vastly broad scope to the tough legacy regime, the FCA is clear that parties should not anticipate being able to rely on the use of synthetic LIBOR over the longer term, and parties should not use the synthetic LIBOR solution as a reason to postpone or avoid transitioning to risk-free rates.

Restriction on new USD LIBOR use

The FCA confirmed on 5 March 2021 that most USD LIBOR rates will continue to be published, and will remain representative, until 30 June 2023. In line with US regulatory guidance to stop using these rates by the end of the year, the consultation proposes officially restricting new use of these rates in UK BMR in-scope contracts by UK supervised entities after 31 December 2021, with the following limited exceptions:

• market making in support of existing client activity;
• transactions that hedge USD LIBOR exposure on existing contracts;
• novations of USD LIBOR transactions executed before 1 January 2022;
• transactions executed for participation in a central counterparty auction procedure on member default, including transactions to hedge resulting USD LIBOR exposure; and
• for the purpose of interpolation in accordance with contractual fallback arrangements for one-week and two-month USD LIBOR, which will be discontinued from 31 December 2021.

Timing

The consultation closes on 20 October 2021 and a Policy Statement confirming the final tough legacy rules will follow thereafter.

Designation of Article 23A benchmarks

On 29 September 2021, the FCA officially designated one-month, three-month, and six-month GBP and JPY LIBOR as Article 23A benchmarks, with effect from 00:01 on 1 January 2022. Once the designation has taken effect, UK supervised entities under the UK BMR will only be permitted to use these rates in tough legacy contracts. Given the proposed broad scope of the tough legacy regime (see Tough legacy consultation above), this is unlikely to have any practical impact initially, but any narrowing of the tough legacy parameters after 2022 could prove problematic for contracts that have not transitioned away from LIBOR.

Synthetic LIBOR

Compulsion of continued publication on synthetic basis

The FCA has confirmed that it is exercising its power under the UK BMR to compel ICE Benchmark Administration to continue to publish the Article 23A benchmarks on a non-representative, synthetic, basis, for at least twelve months.

Although the FCA may continue to compel publication for up to ten years (subject to an annual review), JPY LIBOR rates are not expected to continue past the end of 2022.

Term rate plus spread

The synthetic rates will be calculated using the methodology proposed by the FCA in June this year, being the sum of the forward-looking term rate for the relevant currency/tenor combination and the applicable ISDA spread.

Authors: Mike Logie and Kirsty McAllister-Jones

1 "Use" in this context is limited to the meaning given under the UK BMR, which includes issuing or calculating payments in respect of financial instruments that are traded on a UK trading venue or via a UK systematic internaliser and entering into certain consumer loans.

2 This includes (i) financial instruments that are traded on a UK trading venue or via a UK systematic internaliser and (ii) certain consumer loans.