On Thursday, 20 May, the UK's Financial Conduct Authority launched a consultation in relation to its proposed use of powers in relation to critical benchmarks. It is inviting comments by 17 June 2021.
As a result of amendments to the Benchmarks Regulation under the Financial Services Act 2021 the FCA can (1) permit some or all legacy use of a permanently unrepresentative critical benchmark designated under Article 23A (and, as a result of that designation, would otherwise be subject to an automatic prohibition on use); and (2) restrict use of a critical benchmark whose administrator has notified the FCA that it will cease to provide the benchmark.
The "legacy use power" is part of the FCA's solution to tough legacy LIBOR contracts. It could help reduce disruption where a contract provides either (1) no alternatives to the critical benchmark; or (2) only inappropriate ones, and there is no realistic ability to amend the contract to remove reliance on the benchmark.
The FCA can exercise its legacy use power to advance consumer protection and/or protect the integrity of the UK financial system. In the consultation, the FCA makes clear that it will be more likely to intervene on consumer protection grounds where there are retail consumers of the benchmark, and the harmful issues will be widespread. The FCA also applies this second criterion to the integrity grounds.
The consultation flags certain situations where the FCA believes the alternatives to its use of the legacy use power are inappropriate, and invites responses. These situations seem compelling.
The FCA envisages that the power may be used to permit only limited legacy uses e.g., for a time-limited period or to calculate termination payments. However, tough legacy issues which can be resolved by just a little more time will surely be rare.
Possibly the most interesting section of the consultation comes in relation to the further considerations the FCA will take into account in relation to the legacy use power. One of these is that the FCA explains that its preliminary view is that a forward-looking term risk-free rate would be a likely input to any synthetic methodology it allows, but they worry this will give rise to its own issues because the term rates would be based on prices in the RFR derivatives market - and where derivatives can continue to use LIBOR, liquidity in the RFR market would inevitably be lower. Perhaps this means that the FCA will not want derivatives to benefit from its limited use power. Other considerations the FCA say they might take into account include (1) international consistency; (2) whether there has been non-compliance with obligations to apply suitable fallbacks; and (3) the degree to which it can set out clear and practicable criteria for the market.
The "new use restriction power" has a more limited application, but the FCA consultation makes clear they envisage using it relation to US dollar LIBOR settings continuing to June 2023. Once again, the FCA can exercise it only where it would advance its consumer protection or integrity objectives, and the consultation focuses on issues of system-wide operational risk, financial stability and orderliness of the benchmark over the wind-down period.