Emma RadmoreTogether with the European Financial Markets Lawyers Group, on 19 March 2021 FMLC sent a letter to regulatory authorities in key jurisdictions urging cooperation in relation to the discontinuance of LIBOR.
Given the problems of divergence and overlap that arise from the legislative approaches adopted by authorities in the UK, EU and US, the letter observes that market transactions could become subject to conflicting legal or regulatory requirements and stresses that international coordination around the exercise of any powers to adapt benchmark methodology and/or the terms of financial transactions is essential to avoid significant market confusion.
Examples of issues that may arise identified in the letter include:
- LIBOR could exist under English law as a screen rate but be in cessation as a methodology and/or as a measure of London interbank lending rates and therefore replaceable by the statutory replacement rate (SRR) under the proposed E.U. regime. In the case of cross-border contracts, the SRR will not be automatically incorporated into a contract with an EU entity where that contract is governed by English law and that may cause a surprising and possibly chaotic result as far as the entity itself is concerned. Contracts involving EU entities with overseas elements could be subject to competing interpretations as to which floating price can be supported.
- A major concern is the potential disparity of fallback rates (or synthetic methodologies) which may be identified in different jurisdictions. Whilst it seems that some legislators may identify rates based on backward looking methodologies applied over risk free rates, others might be thinking of applying forward looking methodologies and even within such methodologies themselves, differing solutions may be adopted depending on the relevant product.
- The new powers that will be granted under the UK legislative initiative allow FCA to direct a change in LIBOR methodology. There is a risk that this could provide a platform for litigation or result in the frustration of contracts in agreements that are subject to US or EU law unless there is some form of equivalence mechanism or other similar process to endorse legislative solutions implemented by UK authorities.
- There is also a risk that similar situations might be treated differently under the various legislative systems. For instance, a fallback that fixes at the last publication of, or is based on, the benchmark would be overridden by the US statutory fallback proposal, but pursuant to the European proposal it might be considered as a permanent fallback and thus the SRR would only apply to contracts containing such fallback if certain additional conditions are met. Similarly, LIBOR cessation without prior announcement of its lack of representativeness would trigger the SRR under EU and US approaches, but according to the initial proposal for the UK solution, the cessation
scenario is not covered and only the lack of representativeness of LIBOR would allow FCA to direct a change in the methodology.
Identical letters have also been sent to the Bank of England, the Working Group on Sterling Risk Free Reference Rates, the European Commission, ESMA, the FCA, the FSB and IOSCO.