UK government to tackle tough legacy Libor contracts

British chancellor Rishi Sunak has said the UK government will use upcoming amendments to the financial services bill to give the Financial Conduct Authority (FCA) the power to manage the orderly transition from the London interbank offered rate (Libor) to alternative rates.

Included in the government’s legislation is a means for the regulator to tackle “tough legacy” contracts, which are slowing the transition away from Libor to approved alternative interest rate benchmarks. These are contracts, which lack relevant fall back provisions and where it is difficult to forge an agreement between parties to financial agreements, such as loans or derivatives contracts, that use Libor for their pricing. Most of these contracts are either based on English or New York state law. 

In April, the New York state legislature took the lead by coming up with potential legal solutions for tough legacy contracts, which would, for example, override existing fallback language if it holds back the transition. 

Governments want interest rate benchmarks to be based on robust methodologies with real transactions following evidence in 2012 that traders had been manipulating Libor to boost their bonuses. 

Consistent outcomes

UK Finance, which represents UK banks, welcomed Mr Sunak’s statement, saying it provides clarity, removes uncertainty for customers and lenders trying to ensure fair and consistent customer outcomes.

“While the detail is still pending, this announcement does seemingly remove one of the key impediments to financial services firms cracking on with their customer outreach projects,” said Brett Aubin, head of regulatory response at compliance firm Konexo UK. He added that it will hopefully spur industry bodies to finalise the much needed fall-back language and help clear other roadblocks to the Libor transition process. 

“The new Bill isn’t introducing a wholly new area into the regulatory perimeter. The UK already has regulation in place for critical benchmarks, which many jurisdictions don’t. Interestingly the government has set its face against imposing legal changes on Libor referencing contracts, instead both strengthening and lengthening the FCA’s arm when it comes to ‘tough legacy’ issues that can’t be resolved before end-2021,” explained Claude Brown, a partner at law firm Reed Smith. 

He welcomed provisions to strengthen laws to stop the use of benchmarks which are no longer representative with the regulator being able to specify limited continued use in legacy contracts, thereby tackling ‘tough legacy’ issues head on. “New FCA powers to direct a change in methodology when calculating (interest) are also particularly noteworthy for those following transition efforts,” he said.

This article first appeared in The Banker's sister publication Global Risk Regulator.