Monthly Archives: July 2020

The Bank of England (BoE) provides liquidity to market participants and lends to firms against a wide set of eligible collateral. To encourage market participants to move away from LIBOR, the BoE has announced new policies for the treatment of LIBOR-linked collateral in the BoE’s Sterling Monetary Framework lending operations. Specifically:From 1 April 2021, the BoE will apply increasing haircuts on all LIBOR-linked collateral maturing after 31 December 2021. This means that the value of the LIBOR-linked collateral against which the BoE is lending will be reduced by an increasing percentage until the end of 2021. Haircuts are scheduled to reach 100% by 31 December 2021.From 1 April 2021, any LIBOR-linked collateral issued on or after that date and maturing after 31 December 2021 will be ineligible for use in the Sterling Monetary Framework.These milestones for LIBOR-linked collateral have recently been revised to account for the temporary disruption caused by the Covid-19 pandemic and resulting changes to the interim milestones announced by the Working Group on Sterling Risk Free Rate Transition (the Working Group) on 29 April 2020. In particular, the Working Group has announced that all new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease by the end of Q1 2021 (previously end of Q3 2020).Although the impact of the Covid-19 pandemic has delayed certain milestones, the date from which the BoE intends to apply a 100% haircut on LIBOR-linked collateral (i.e. implying effective ineligibility) remains 31 December 2021. This shows that the central assumption remains that firms cannot rely on LIBOR being published after the end of 2021.

The UK Government announced on 23 June 2020 that it intends to introduce new legislation to give the UK Financial Conduct Authority (FCA) enhanced powers in circumstances where (i) LIBOR ceases to be representative of the market and (ii) its representativeness cannot and will not be restored. This is intended to solve the problem of “tough legacy” contracts by giving the FCA the power to protect consumers and market integrity in relation to those contracts (which the FCA envisage will be a “narrow band”). “Tough legacy” contracts in the context of LIBOR transition are existing contracts referencing LIBOR which extend beyond 2021 and cannot realistically be renegotiated to use a different benchmark rate or to add new robust fallback provisions. This announcement from the UK Government follows the Paper on the identification of Tough Legacy issues published at the end of May by the Working Group on Sterling Risk-Free Reference Rates (the Consultation Paper) which considered “tough legacy” issues across asset classes in the UK and concluded that there is a case for action to address these exposures.The proposed legislation would:Grant the FCA powers to require an administrator of LIBOR to alter its methodology in calculating the benchmark if LIBOR ceases to be representative of the market and its representativeness will not be restored (which is expected to occur when panel banks are no longer required to make submissions after 1 January 2022). This would not restore the benchmark’s representativeness, but could sustain publication of a robust rate until its cessation; andAllow the FCA to permit the continued use of LIBOR for a narrow category of “tough” legacy contracts where it considers this appropriate.The UK Government intends to introduce those proposed new powers in the forthcoming Financial Services Bill.This progress towards solving the problem of “tough legacy” contracts is welcome. However, of itself this proposed legislation does not remedy the current inherent uncertainty parties face. For example:It is not entirely clear what “tough legacy” contracts are. The Consultation Paper refers to “those contracts that cannot be dealt with in any other way” apart from continuing to reference LIBOR. It is unclear whether, for example, a contract where the parties simply cannot reach commercial agreement on the replacement for LIBOR would be considered a “tough legacy” contract. It may be that the FCA will have powers to adjudicate whether a particular legacy contract is “tough”, or alternatively it might be that these proposed powers will simply be a default position for any legacy contract continuing to refer to LIBOR. To some extent this is understandable – the FCA is unlikely to risk discouraging participants from amending their existing contracts by providing a “default” fallback. Nevertheless, it remains unclear when these powers will be triggered and to which contracts they will apply.In any event, even if “tough” legacy contracts can be identified, the other problem is that those contracts (and how they operate) still remains inherently uncertain post-31 December 2021 because there is no guidance yet and seems unlikely to be for some time as to what new methodology will be used to calculate “LIBOR” in those circumstances. Also the FCA admits that it may well not be able to create any new methodology for some LIBOR tenors/ currencies.The FCA are proposing yet more wide ranging consultations and discussions with market participants to establish how best to alter the LIBOR methodology post-31 December 2021. It will likely be many months before the true picture of what will be available post-2021 becomes clear. This makes it more difficult for parties to consider their options for legacy contracts between now and the end of 2021, although an optimistic view suggests that the “cliff edge” of 31 December 2021 may no longer be so steep if the FCA intends to provide some support on the other side. Unless and until clearer guidance becomes available, it is impossible to tell to what extent these powers will assist parties to resolve disagreements about how to deal with contracts referencing LIBOR extending beyond 2021. The announcement from the UK Government can be found here: https://www.parliament.uk/business/publications/written-questions-answers-statements/written-statement/Commons/2020-06-23/HCWS307/. In connection with the announcement, the FCA has also issued the following statement: https://www.fca.org.uk/markets/transition-libor/benchmarks-regulation-proposed-new-powers.