Critical Benchmarks (References and Administrators’ Liability) Bill [Lords]

Bob Stewart Excerpts

2nd reading
Thursday 18th November 2021 Commons Chamber

[John Glen]

I cannot give the hon. Gentleman a precise figure. However, in my remarks now and further on, I will give an explanation of those that are excluded and therefore necessitate the creation of this synthetic rate. If he would just bear with me, I will get to the point, and he should feel free to intervene subsequently if he is not satisfied.

The Bill builds on the provisions of the Financial Services Act 2021, as I mentioned a moment ago. This provided the FCA with the powers to effectively oversee the cessation of a critical benchmark in a manner that protects consumers and minimises disruption to financial markets. If I may, I would like to take a few minutes to put the Bill into context.

LIBOR seeks to measure the cost that banks pay to borrow from each other in different currencies and over various time periods. It is calculated using data submitted by a panel of large banks to LIBOR’s administrator, which is the ICE Benchmark Administration. It is referenced in approximately $300 trillion of contracts globally. It is used in a huge volume and variety of contracts, including in derivatives markets, mortgages, consumer loans, structured products, money market instruments and fixed income products. For example, a simple loan contract may say that the interest payable is LIBOR plus 2%. In this example, LIBOR represents the cost to the lender of getting access to the money to lend it out, and the 2% represents the additional risk to the lender associated with making the loan.

Back in 2012, it emerged that LIBOR was being manipulated for financial gain. Following the subsequent Wheatley review, LIBOR came under the regulatory jurisdiction of the FCA in 2013. That led to significant improvements to the regulation and governance of LIBOR. However, in 2014 the G20’s Financial Stability Board, known as the FSB—not to be confused with the Federation of Small Businesses—declared that the continued use of such rates, including LIBOR, represented a potentially serious source of systemic risk. The FSB said that financial markets should voluntarily transition towards the use of more robust and sustainable alternatives. It reached that conclusion due to the structural decline in banks borrowing from each other through the unsecured wholesale lending market. That has meant in turn that LIBOR has become more and more reliant on expert judgments, rather than based on real transaction data. In other words, the market that this systemically important benchmark seeks to measure increasingly no longer exists, which underscores the fundamental need to transition away from LIBOR.

Since the FSB’s recommendation, the Government, the FCA and the Bank of England have worked together to support a market-led transition away from use of the LIBOR benchmark. Primarily, they have encouraged contract holders voluntarily to move to robust alternatives, in accordance with guidance from the FCA and the Bank of England, before the end of the year. At the end of the year, LIBOR’s panel banks will stop making the submissions to the administrator on which LIBOR is based. At that point it will therefore become unrepresentative, and the administrator will cease publishing in any setting where the FCA has not required continued publication using the synthetic methodology. The vast majority of contracts are expected to have transitioned away from LIBOR before that happens. For example, it is estimated that 97% of all sterling LIBOR referencing derivatives will have transitioned by the end of the year.

Despite extensive work and progress, there remains a category of contracts that face significant contractual barriers to moving away from LIBOR by the end of the year, and measures in the Financial Services Act 2021 sought to provide a safety net for those so-called tough legacy contracts. Through the Act, the Government granted the FCA powers to designate a critical benchmark as unrepresentative, if it determines that the benchmark is, or is at risk of becoming, unrepresentative—in other words, that it no longer accurately represents what it seeks to measure—and that it is not possible or desirable to restore its representativeness. The Act also provided the FCA with powers to compel the administrator of such a designated benchmark to continue to publish it for a temporary period of up to 10 years, to prohibit new use of the benchmark, and to require the administrator to change how the benchmark is calculated.

[Bob Stewart (Beckenham) (Con)]

I thank my very good friend the Minister for allowing me to intervene. He understands all this, and I understand some of it, but not much. I speak, however, as someone who is concerned. If we are moving away from LIBOR, is such a move likely to result in a greater cost to those who wish to borrow money?

--- Later in debate ---

[Mr Pat McFadden (Wolverhampton South East) (Lab)]

The programme motion we approved a short time ago allocated up to six hours for this process. As I look around the Chamber, Madam Deputy Speaker, I feel that span of time may prove adequate for our purposes today, but one cannot be sure.

I am grateful to the Minister for his explanation of the Bill and for the briefing he arranged prior to today’s debate. I am also grateful to the FCA for the briefing on the Bill that I requested a week or so ago.

As the Minister said, we all know the background to the desire to move away from LIBOR as a benchmark for financial contracts. A decade or so ago, a scandal of LIBOR manipulation was uncovered, whereby traders who submitted estimates of borrowing rates were manipulating the submissions for the benefit of the institutions they worked for, and indeed for themselves and the accounts they managed. That left financial markets subject to corruption for private gain.

Not surprisingly, in the wake of that there were inquiries, including a major cross-party one in this House on which I served. It opened the door to wider cultural issues in banking about risk and reward, and asked the question: for whose benefit exactly were those institutions being run? It also provided the spectacle of the chief executives of some of the banks, some of the highest paid people in the world, claiming, one after another, that they did not know what was going on in their organisations until they first learned about it through the newspapers.

In the wake of all that, regulators around the world agreed to move away from a benchmark based on supposed expert judgments, to benchmarks based on actual trades. However, that move away from LIBOR has been more difficult than first thought, because of the volume and the endurance of the contracts involved. As the Minister mentioned, it is thought that there are some $300 trillion-worth of contracts based on that benchmark. Some of those will not be transferred to new benchmarks by the deadline set at the end of this year, and that is where the Bill comes in.

Clause 1 seeks to ensure continuity between LIBOR and its successor for contracts which have not managed to move to a new benchmark by the end of the year. There was an exchange during the Minister’s speech, between him and the SNP spokesperson, the hon. Member for Glenrothes (Peter Grant), where the question was asked: how much are we talking about here? In the debates in the other place on the Bill, the figure of about £450 billion was, I believe, mentioned as the worth of such outstanding contracts. If that estimate is correct, then there are still very substantial contracts that could be affected by the switch.

The Bill empowers the FCA to produce a new benchmark, to be called synthetic LIBOR, which, as the Minister said, will be regarded as LIBOR for the purposes of the contracts involved. That will run alongside the Bank of England’s new benchmark, called SONIA—sterling overnight index average. If SONIA is the daughter of LIBOR, then synthetic LIBOR can be regarded as the ghost of LIBOR. The Bill sees the two walking together, travelling side by side.

In both the public debates on the Bill and at briefings from the FCA, it has been estimated that, in terms of what it would mean as an actual interest rate, synthetic LIBOR will be about 12 basis points higher than actual LIBOR now. My first question for the Minister, therefore, is why should synthetic LIBOR be set at 12 basis points higher than actual LIBOR and what will that mean for the contracts involved?

[Bob Stewart]

Forgive me for intervening yet again, but, for the normal person, does synthetic LIBOR and 12 basis points mean a 12% increase on what he or she might pay?

[Mr McFadden]

No, it does not mean that. It means just over one-tenth of 1%, as there are 100 basis points in 1%.

Twelve basis points, or just over a tenth of 1%, might not sound like a huge margin, but when we are talking about contracts worth up to £450 billion, small differences in rates can add up to a lot of money. To illustrate that, let us consider the position of mortgage holders. There are an estimated 200,000 mortgages based on LIBOR. My next question to the Minister is why have those mortgages not moved away from LIBOR in the years since the regulator encouraged contracts to do so? What has left them stuck on LIBOR before the approaching deadline of the end of the year? Will the move to synthetic LIBOR mean that these mortgages will pay rates of 12 basis points higher than if the move had not taken place?

The FCA published a Q&A on these matters earlier this week, which stated that

“there may be a small increase in your mortgage payment in January 2022 compared with your mortgage payment in December 2021.”

It looks as though a payment rise is on the way for those 200,000 mortgages. That, of course, comes alongside a very live debate in the Monetary Policy Committee about changes to the Bank rate. Does the Minister think that those who hold mortgages based on LIBOR, which, in the buy-to-let sector, means about one in 20 mortgages—that is not an insignificant proportion—realise that that change, which was flagged by the FCA the other day, is coming as a result of the Bill? Have the Treasury or the FCA estimated what the total cost of that might be to UK mortgage holders?

That brings us to the potential for legal action over the changes envisaged in the Bill. That is the difference between this proposal and what the Minister referred to as changes in the Bank rate, because this change is being brought about through legislative action whereas Bank rate changes are as a result of a decision by the Monetary Policy Committee. The question of legal action arises because if contracting parties have agreed a contract on the basis of one benchmark, might they take legal action if the move to a new benchmark ends up costing them more?

As I understand it, proposed new article 23FA(6) in clause 1 attempts to close off the possibility of legal action as a result of a contract moving from LIBOR to synthetic LIBOR—the ghost of LIBOR—which, in this example, would close the door on any potential legal action from disgruntled mortgage holders. I would be grateful if the Minister confirmed that that is the correct interpretation of proposed new article 23FA(6). To make this matter even more complex, proposed new article 23FA(7) in clause 1 leaves open the possibility of legal action, as long as the basis for it is not action taken under clause 1 of this Bill—that is, it is not simply the move from LIBOR to another benchmark authorised by the FCA. Again, I would be grateful if the Minister confirmed that my understanding of that is correct.

In the equivalent American legislation—LIBOR is used all around the world—there is what is known as a safe harbour provision: a mechanism to prevent contracting parties from engaging in legal action as a result of these changes. Will the Minister explain why the Government rejected that option for the UK? What is the difference between the restrictions in proposed new article 23FA(6) in clause 1 and the safe harbour legislation that has been put on the statute book in the United States?

Clause 2 also deals with legal action. It insulates from legal action the administrators of benchmarks, who in this case will work on behalf of the FCA, who, in turn, will work on behalf from Parliament, assuming that the Bill is passed. We can see the logic of insulating a public agency from legal action if it is carrying out a duty that stems directly from legislation, but the same clause states that it does not remove liability entirely—for example, over the exercise of discretion or timing of the publication of a benchmark. Will the Minister explain to the House, under clause 2, just how insulated from legal action are the FCA and the administrators that are authorised as a result of the Bill?

Underlying all that is the question of why we need this legislation at all. Around a year ago, the Minister and I spent many a happy hour debating the Financial Services Act, both on the Floor of the House and in Committee. That Act, as we will both fondly remember, authorised the publication of the alternative benchmarks in the first place, so why, after our spending all those happy hours putting that Act through Parliament, have the Government concluded that they have to return with further legislation? What was it about the Financial Services Act that left the picture incomplete? How do we know that this is the last piece of the jigsaw and that the Treasury will not have to come back a third time to fill in other potential gaps?

There is also the important issue of the timescale or longevity of these measures. They are being sold by the Government as a transitionary process—a bridge from LIBOR to a world without LIBOR—but, as long as they are in place, we have SONIA, LIBOR’s replacement, operating alongside the ghost of LIBOR in the form of synthetic LIBOR. Is all this just kicking the can down the road or do the Government really have an exit plan for these tough legacy contracts? If they have not been able to move these contracts away from LIBOR now, when, for years, the regulators have been flagging that they should do so, why does the Minister think that they will move away from the ghost of LIBOR?

It is now almost a decade since the original scandal of LIBOR rate manipulation was uncovered. The Financial Services Act, which gives rise to the powers that we are debating, talked about a transitional period of up to 10 years while this new alternative benchmark might run alongside others that have succeeded LIBOR, so it is conceivable that it could take the best part of 20 years to go from the uncovering of the original scandal to the final move away from LIBOR. What is the likelihood that the Minister, who has been very long-serving in his post, or his successor will have to come back to the House with more legislation on this matter because, even after all that length of time, it is not enough to wind down all the contracts that we are talking about?

We will not oppose the Bill today because we understand that continuity of contracts is in the public interest, but it is not clear to us how temporary a regime this is. I would be very grateful if the Minister could respond on exactly why this legislation was needed in the first place and how long it may last, and to the other questions that I have put to him this afternoon.