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

Lord Tunnicliffe Excerpts

2nd reading
Wednesday 13th October 2021 Lords Chamber

[Lord Agnew of Oulton (Con)]

My Lords, I thank noble Lords for their detailed and collaborative contributions on this very technical Bill. I would particularly like to welcome and thank my noble friend Lord Altrincham for his excellent and personal maiden speech. I know that his experience in financial matters will be of great benefit to us all.

The Bill reinforces the provisions in the Financial Services Act 2021 that provide the FCA with powers to oversee the wind-down of a critical benchmark in a manner which protects consumers and minimises disruption in financial markets. In doing so, it provides key support to the Libor transition and market confidence.

I will try to address a number of the questions raised by noble Lords this evening, but I will write on the more technical ones on which I may not be able to come up with the answers immediately.

I start with the noble Lord, Lord Sharkey, and his concern about the late running of this, so to speak. I accept his point that work could possibly have been done before the Financial Services Act 2021 received Royal Assent. The FCA feels strongly that it needs to follow an orderly and sequenced process to consult first on the framework for decisions and then on the decisions themselves, but I accept that the timing will be tight.

The noble Lord, Lord Sharkey, also asked why this year is taken as the cut-off. This date was selected back in 2017 after engagement with panel banks, so it has been in the works for quite a long time and there has been time for the industry to plan for it. We have had very close engagement with the US and the timings are aligned. It has now said that the new use of US dollar Libor rate will stop at the end of this year, following supervisory guidance from the US and UK and other international authorities.

The noble Lord, Lord Sharkey, also asked about the mechanisms for the synthetic rate to be smoothed. The FCA has confirmed that that is the approach. The synthetic methodology is based on a broad global consensus and it would cause significant market disruption to change course at this point. It is not clear that that would deliver better outcomes for markets or consumers. As discussed at the briefing yesterday, the smoothing has been put in place taking the five-year median rate, but I can write with more detail if the noble Lord would like, as I accept that this is an important issue.

The noble Lord, Lord Sharkey, said he was worried about congestion at the end of the year. We have been clear that the active transition is the main mechanism; we have seen a large transition away from Libor over the last few months. I take my noble friend Lord Blackwell’s point that the latest data shows that some 55,000 contracts are still outstanding, but they are moving quickly. The FCA has taken on board market feedback on distinguishing between contracts that can be amended before the year end and those that cannot. Every step it is taking is to minimise disruption, in line with the objectives.

My noble friend Lady Noakes asked about the cost of funds fallbacks. This legislation provides certainty on how references to the Article 23A benchmark should be interpreted in contracts and other arrangements in which the FCA has exercised powers under the benchmarks regulation to require a change in the benchmark methodology. Where a contract or arrangement has a fallback that is triggered by the temporary or permanent unavailability of Libor, Article 23FA provides that the benchmark continues to be available and consequently that it does not cease to exist, be published or otherwise be made available. This means that the cost of funds fallbacks, which are generally triggered by the unavailability of the benchmark, will not be triggered.

My noble friends Lord Blackwell and Lady Noakes asked what happens after the proposed 10-year period. The legislative framework put in place in the Financial Services Act 2021 allows the FCA to support the orderly wind-down of the benchmark. Specifically, it allows the FCA to impose a synthetic methodology to provide for the continuity of a Libor setting for the benefit of tough legacy contracts for up to 10 years. The Government will continue to work closely with the FCA and the Bank of England to support an orderly wind-down of Libor and will continue to monitor the risks in this area, given its systemically important role in the UK economy.

My noble friend Lord Blackwell asked about the shorter term, after a year. The benchmark regulation provides that the FCA can review the decision to compel continued publication of a synthetic benchmark after a year. The FCA has been clear about the expected direction of travel with regard to the sterling synthetic Libor rate and does not intend that it will cease automatically after a year.

The noble Lord, Lord Sharkey, and the noble Baroness, Lady Kramer, are concerned about FCA accountability and, linking to that, parliamentary oversight. The FCA must operate within the framework of statutory duties and powers agreed by Parliament. The FCA is also fully accountable to Parliament for how it discharges its statutory functions. This direct accountability to Parliament reflects the FCA’s statutory independence and the fact that it is solely responsible for everyday operational decisions, without government approval or direction, and so is primarily accountable for them. The legal framework ensures direct accountability of the FCA to Parliament, including through a requirement for it to produce annual reports and accounts which are laid before Parliament by the Treasury.

The FCA is subject to full audit by the NAO, which has the associated ability to launch value-for-money studies on the FCA. The FCA is subject to scrutiny from Select Committees. The Treasury is the FCA’s sponsor in government; it is responsible for the statutory framework of financial services regulation and for the continued effective operation of the FCA as part of that framework. The mechanisms for the FCA can be directly accountable to the Treasury. This includes direct controls over appointments to the FCA board and powers under the Financial Services Act 2012 to commission reviews.

The noble Lord, Lord Sharkey, and my noble friend Lady Noakes asked about safe harbour. The responses to the Treasury consultation earlier this year identified the risks that parties may look to contest the continued publication of synthetic Libor by its administrator, or to seek damages against the administrator. This risk might be heightened if other avenues of litigation are closed off to parties by the Bill.

Where the administrator of an Article 23A benchmark is subject to legal challenge for complying with statutory requirements imposed by the FCA under the benchmarks regulation, it could impose a significant unreasonable and unmerited burden on the administrator of an Article 23A benchmark. If faced with too much legal risk, the administrator may seek to resign from administering the benchmark, which in turn risks causing disruption. Such action could serve to erode parties’ confidence in using the benchmark, undermining the operation of the FCA’s powers to oversee an orderly wind-down of it.

My noble friend Lady Noakes also asked about alternative benchmarks. The focus of this legislation is on providing legal certainty regarding the operation of the FCA’s powers to wind down this critical benchmark. Where contractual parties have acted in line with regulatory guidance to transition the contract to an alternative rate, the Government do not see that there is a need for further legislative clarity. The Government continue to encourage parties to contracts that reference Libor to transition those contracts to alternative benchmarks wherever possible, in accordance with regulatory guidance.

Several noble Lords, including my noble friend Lord Blackwell, asked about legal certainty. It is the Government’s view that it is appropriate to provide legal certainty as to how references to Libor should be interpreted in contracts or other arrangements, once the switch to the synthetic rate occurs. This legislation comprehensively addresses the risk of contractual claims relating to the exercise of the FCA’s powers to wind down a benchmark, as identified in response to the Treasury’s consultation on this matter.

It is important to stress how narrow the contractual continuity provision is. It does not protect the parties to the contract from all legal challenge. This would result in parties to those contracts not being able to challenge any element of that contract, and would be too broad. It simply specifies that where a contract references Libor, that should be read as referring to synthetic Libor. The effect of that is that legal claims cannot be brought on the basis that synthetic Libor is not included in the contract.

As the home jurisdiction of Libor’s administrator, the UK has a unique role to play in minimising financial stability risks and disruption to financial systems arising from the wind-down, both in the UK and globally. This plays to the comments made by several noble Lords in relation to London’s reputation as a financial centre and the unfortunate events that surrounded the problems with Libor 12 or more years ago.

In the UK framework, the FCA will be able to provide for the continuation of Libor settings under a synthetic methodology. Subject to the legislative framework in other jurisdictions, any change of methodology imposed by the FCA would flow through to global users of Libor contracts continuing to reference the rate. By taking this approach, the UK has provided a global solution rather than an approach that would have been effective only in the UK.

My noble friend Lord Blackwell asked about the methodology. Noble Lords will appreciate that setting this methodology is a responsibility that Parliament has granted to the operationally independent FCA, within the parameters established by the recent Financial Services Act. However, the FCA has an overriding responsibility to act in the best interests of consumers in this country. It is also important to note that the FCA’s approach is in line with the global consensus.

As we all acknowledge, and as I said in my opening remarks, Libor is mostly used by sophisticated financial operators, not retail investors. We estimate that there are only around 200,000 mortgages left on Libor, with that number estimated to fall to somewhere between 50,000 and 100,000 in the next few months. The synthetic Libor rate is a last resort and regulators have been encouraging markets to move to alternative rates for some time.

I remind noble Lords that the Financial Services Act 2021 allows the FCA to impose a synthetic methodology only if it considers it desirable to do so to protect consumers or protect and enhance the integrity of the UK’s financial system. Furthermore, the synthetic rate seeks to provide a reasonable and fair approximation of Libor while removing a major factor in its volatility: the variable credit spread, which has often spiked in times of economic stress. Reducing volatility will benefit consumers who pay interest with reference to Libor.

I will write to the noble Lord, Lord Eatwell, on his specific points; I am afraid that I do not have that information to hand at the moment.

This Bill is vital to the protection of consumers and the integrity of UK markets. I would be happy to arrange another detailed technical session in a similar form to the two we have had so far, because I am aware of how technical this Bill is. I hope that we have noble Lords’ support.

[Lord Tunnicliffe (Lab)]

My Lords, may I raise a bureaucratic point before the Minister sits down? He intends to put letters in the public domain through the medium of the Library. It would be convenient if he could simultaneously copy them to everybody who has participated in the debate and registered interested parties like me.

[Lord Agnew of Oulton (Con)]

I would be happy to do that. I am pleased to see the noble Lord, Lord Tunnicliffe, back here without Covid; we were worried that he might have had it. I will certainly do that.