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

Peter Grant Excerpts

2nd reading
Thursday 18th November 2021 Commons Chamber

[The Economic Secretary to the Treasury (John Glen)]

I beg to move, That the Bill be now read a Second time.

Many Members will have heard of LIBOR in the context of the manipulation scandals almost 10 years ago. The London interbank offered rate is the rate at which banks lend to each other in wholesale markets. As the right hon. Member for Wolverhampton South East (Mr McFadden) knows too well, from his experience on the Parliamentary Committee on Banking Standards, a number of changes were made to the administration and governance of LIBOR as a result of that scandal.

Stringent and effective regulation means that LIBOR is now effectively supervised. However, it is no longer robust, as I will explain, and is due to be wound down. The Financial Conduct Authority has confirmed the process to wind down the LIBOR benchmark by the end of this year. Most contracts that reference LIBOR will have transitioned to a different rate before the end of 2021, in line with the guidance of the regulators, but there remain a proportion of contracts that will not have done so.

[Peter Grant (Glenrothes) (SNP)]

It is comforting to hear that most of these contracts will have transitioned over. In the Lords, the Government estimated that the total value of those contracts was about £300 trillion, so even if a tiny percentage of them do not transition over, they could still represent a significant amount of money. Does the Minister have any indication of the number and value of contracts that he thinks will still need to be covered by this Bill—not as a percentage, but in actual pounds value?

[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.

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[Peter Grant (Glenrothes) (SNP)]

I am grateful to the Minister for setting out so clearly the background to the Bill and why it is needed, and for his answers to some of the questions that I raised. I do not think that anyone would doubt the need for this Bill or something very similar. LIBOR is clearly not fit for purpose, but we cannot just shut it down without replacing it with something, and that something has to have some kind of statutory backing.

As I mentioned, there have been concerns raised inside and outside Parliament about exactly how the Bill is worded and whether its present wording is the best possible way to achieve the objectives that we all want to be delivered. By far the biggest of those—the shadow Minister, the right hon. Member for Wolverhampton South East (Mr McFadden), mentioned this as well—is the degree of immunity from legal action that has been offered to the administrators of critical benchmarks. Again, I do not think that anyone can reasonably oppose the argument that we need to provide some kind of immunity—otherwise, it would just become a circus and the only people who would benefit are lawyers—but there is a question about whether the Bill goes far enough in this regard. Will the Minister respond in more detail to that question when he sums up?

The same questions were raised in the Lords on Second Reading on 13 October. I have to say that although in reply Lord Agnew made a succinct and powerful argument about why some immunity was needed, I do not feel that he addressed the question that had been asked: whether the immunity that the Bill gives is at the right level and goes far enough.

It is unfortunate that we do not have the chance to call expert witnesses to the House and question them on the record about the relative merits of the approach to immunity that the Bill proposes, versus the alternative safe harbour system that the shadow Minister mentioned and that I understand is being used in the United States of America. Could the Economic Secretary give an indication of whether safe harbour has additional risks that we are not aware of? Is there a risk that it could introduce more risk and more damage to the system, rather than less?

LIBOR is referred to in about $300 trillion-worth of financial contracts around the world. The shadow Minister mentioned that about £450 billion-worth is likely to end up being covered by the Bill; my quick guess at the arithmetic is that that will mean less than 0.2%. However, that is the danger of referring to percentages: we could say that 99.8% of contracts will successfully transition, but that still leaves £450 billion-worth that will not. We therefore need to make sure not only that the Bill passes, but that we get it right. The consequences of getting it wrong, or even not quite right enough, could be significant.

It has been mentioned that LIBOR is used to determine the interest rate of about 200,000 mortgages in the UK. The Financial Conduct Authority says that it expects the “majority” to have transitioned by the end of year. That could mean that only one contract of that sort will be left in the whole United Kingdom, but it could mean that there will be 99,999. It makes quite a difference.

About half of those 200,000 mortgages are for people in their own homes, and half are for buy to let. Let us not think that it is a harmless thing when buy to let goes wrong; the vast majority of buy-to-let properties are still somebody’s home, even if that somebody happens not to be the owner. If the worst happens and any of those mortgage borrowers get into serious difficulty, it will be no comfort to them whatever to be told that 11 million other people are blissfully unaware of the problem. To someone with a mortgage that goes bad, the badness rate for mortgages is 100%. We should never forget that.

I understand why the Economic Secretary was reluctant to commit to any kind of compensation scheme in future, but I would certainly appreciate it if he confirmed that the Government will not completely close the door on that possibility should circumstances demand it. We do not foresee a problem just now, but nobody thought that LIBOR could be manipulated as it was, until the fraudsters discovered that it could. Nobody thought about the problems that mini-bonds could cause, until the fraudsters found a way of causing them.

A further question on legal immunity arises from the global use of LIBOR. The Bill can give administrators immunity from being sued in courts in any UK jurisdiction, but is the Economic Secretary aware whether the transition away from LIBOR might leave them with any increased risk of being sued in overseas courts? Obviously we cannot prevent people from bringing actions in overseas courts, and even if they fail it is still an expensive and disruptive process for the administrators to have to defend themselves. Although we cannot legislate against the practice, is he aware of any circumstances in which the Bill could increase the risk of legal action in an overseas court?

The Financial Conduct Authority will have regulatory responsibility in relation to the Bill. Notwithstanding my well known views about its fitness for purpose, within the current regulatory framework the FCA is where responsibility should reside. However, I share the concerns raised in the Lords about the FCA’s accountability to Parliament. Effectively, the Lords Minister’s response was that there is direct statutory accountability from the FCA to Parliament, but that is not enough. Accountability achieves nothing if Parliament does not have the proper procedures in place to make that accountability work. The arrangements we have in place just now do not work.

The Treasury Committee is overloaded with work. It simply does not have enough hours in the day to hold the FCA and other regulators to account to the necessary extent. I would almost argue that the FCA merits a separate Select Committee of its own, but when we add the scrutiny needed of other regulators in the financial services sector, there is a strong case—an unarguable case, I believe—for establishing a separate Select Committee, or even a Joint Committee of both Houses, dedicated to holding our financial services regulators to account. We have seen what happens when they get it wrong. I do not think that Parliament is doing its job sufficiently just now to keep them held to account.

The LIBOR rate-fixing scandal reminded us that in the financial services sector, as in many other places, there is no limit to the ingenuity of some very senior people in positions of great trust when it comes to devising frauds on a massive scale. There is no loophole in regulation too small to be exploited.

I support the Bill’s passage. I have not tabled any amendments, but I will agree to the unamended Bill with my fingers crossed, because I fear that only time will tell whether it is 100% watertight. In the sometimes murky environment in which the Bill will operate, anything less than 100% will not be enough.

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

Peter Grant Excerpts

Committee stage & 3rd reading
Thursday 18th November 2021 Commons Chamber

[Mr McFadden]

I am grateful to the Minister and have a few questions for him, all of which relate to clause 1. The methodology for calculating synthetic LIBOR is the five-year average picked by the FCA. Were other possible methods considered? What impact would they have had on the interest rate?

Secondly, the Minister referred to the rate bouncing around: on one day it could be less than real LIBOR and on another day it could be more. I believe that the FCA has used the figure of 12 basis points. For clarity, is that a fixed-term difference going forward, or will synthetic LIBOR vary on a daily basis, just as real LIBOR can?

On Second Reading, we talked about mortgages. However, as the Minister rightly said, a far greater sum of money based on LIBOR is in the derivative markets. What estimate have the Government made of the Bill’s impact on those markets?

Paragraph 6 of new article 23FA, which we have touched on a few times, tries to limit or define the scope of legal action taken as a result of the move from LIBOR to synthetic LIBOR. How might that influence any attempt at judicial review? How confident is the Minister that someone could not try a judicial review of this attempt to close down the option of legal actions taken as a result of a Government-mandated move in financial benchmarks?

The Minister referred to the discussion of fall-back provisions on page 3 of the Bill. For clarity, does this mean that some contracts will not transfer to synthetic LIBOR but will transfer to something else, depending on whether there is a fall-back provision in the contract? If there is a fall-back provision and it is not synthetic LIBOR, what will it be? If there is a fall-back provision that could have a different rate from synthetic LIBOR, how will contracting parties decide which one to use? Will the fall-back rate, if such a thing is specified in a contract, automatically take precedence over synthetic LIBOR, or might there be room for argument about which alternative rate to use?

Finally, there is the question of timescale and how long this will last. The Minister talks about encouraging remaining contracts to move off what will now be synthetic LIBOR. Indeed he said that, if we have to, we could pass further legislation. Is there anything more that can be done, other than encouragement, or are contracts not moving away from LIBOR because it is a better rate and, ultimately, what people care about is the interest rate they pay? I wonder how temporary this will be. Are we kicking this can down the road with nothing other than encouragement for a group of contracts that have stubbornly stuck to LIBOR despite all the regulator’s enthusiasm? Is there anything between the Minister’s encouragement and future legislation that might change this situation?

[Peter Grant]

I will not detain the House by repeating my comments on Second Reading. I am grateful to the Minister for his answers to a number of my questions, but one question he did not pick up, and on which I hope he can give some assurance, is what happens if something goes badly wrong with people’s mortgages. The small percentage of people who have mortgages covered by this legislation—although it could potentially be quite a big number of people—are now, through no fault of their own, quite literally staking their home on our getting this right. Although I appreciate that the Minister will not commit to a specific compensation scheme just now, will he at least give an assurance that the Government have not closed the door on that possibility should unforeseen circumstances lead to it being necessary?

I am also looking for clarity on the precise circumstances in which the administrator does or does not have immunity from legal action. The Minister has said the administrator is covered if it does something the law says it has to do, and it will not be covered if it does something it has chosen to do in a particular way. Does the administrator have discretion on the precise methodology it uses to calculate synthetic LIBOR, and can it exercise its judgment on the numbers it puts into the model? If the administrator has such discretion, nobody needs to sue it for using a synthetic LIBOR model; they can just sue it because of how it has carried out the calculation.

Given the nature of contracts of the value that the right hon. Member for Wolverhampton South East (Mr McFadden) mentioned, a slight change in the published rate can mean a lot of money. Every time the published rate is arguably a wee bit higher or a wee bit lower than somebody else thinks it might have been, one party will win and be quite happy, and the other party will lose and will potentially have a strong motivation to resort to legal action. Are administrators adequately covered against being sued simply because they have published a figure that says the current synthetic LIBOR rate is 1.2% rather than 1.25%? Are there grounds on which they might be sued because those 0.05 percentage points of difference in the published synthetic LIBOR rate either make or lose quite a lot of money?

[John Glen]

It is a pleasure to serve under your chairmanship, Mr Evans.

The right hon. Member for Wolverhampton South East (Mr McFadden) and the hon. Member for Glenrothes (Peter Grant) have raised a number of questions arising from what I said. The Government are clear that we support this transition away from LIBOR by providing additional legal certainty for contracts relying on LIBOR past the end of this year. The provisions of the Bill are vital to using the synthetic rate in an orderly winding down of LIBOR, and they provide protection to consumers and the integrity of UK markets, but there are four or five elements that I will address now.

The hon. Member for Glenrothes mentioned compensation, and we do not anticipate that being an issue. As with all matters, the Treasury keeps things under review. We will continue to monitor what happens as a consequence of this methodology.

Both the right hon. Member for Wolverhampton South East and the hon. Member for Glenrothes mentioned legal action, and it is possible that judicial review could be raised against the FCA on the synthetic methodology it is prescribing for ICE. We think that would be extremely unlikely, given that there has been an active exercise of listening to representations on designing a methodology that has broad credibility. That is fundamental to the integrity of the process. There has been no attempt to develop a methodology in isolation or separate from the consultation with the market.

The right hon. Member for Wolverhampton South East asked about both the future timetable and what will happen with contracts that have fall-back clauses overridden by the effect of this legislation. This Bill provides certainty where a fall-back provision is triggered by a benchmark ceasing to be published or made available. Neither the designation of a benchmark under article 23A of the BMR nor the imposition of a synthetic methodology would trigger the operation of the fall-back provision. Where a contractual arrangement has a fall-back provision that is triggered by other means, this Bill does not affect or override the operation of that clause. For example, it will not override a fall-back triggered by an assessment of unrepresentativeness or a prohibition on the use of the benchmark, provided that the circumstances in which the fall-back was triggered are met.

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[Peter Grant]

I wish to reciprocate in my thanks to the Minister for responding with the courtesy and in the spirit of co-operation that we always get from him in these debates. This is becoming more topical just now, but he deserves credit in setting an example that we would all do well to follow. There have probably been very few Bills to come through this House that have involved so much work beforehand to produce a Bill that, in paper terms, does not appear to be particularly significant. I think we understand that its impact can be quite significant—the impact of not doing it could have been very significant. So may I ask the Minister to take the thanks of my group back to his officials and to everybody else who has contributed to the consultation—those in the FCA and the industry representatives—as I know they have put a lot of work into this as well? As I say, it has not produced a huge number of pages or words of legislation, but I believe it has plugged a potentially catastrophic gap in the regulation of our financial services industry, and they deserve our thanks for that.

Question put and agreed to.

Bill accordingly read the Third time and passed, without amendment.