Critical Benchmarks (References and Administrators’ Liability) Bill [HL] — House of Lords, 2021-10-13
Topic: Domestic Commerce
John Kevin Sharkey (Liberal Democrats, Centre to centre-left): My Lords, I thank the Minister, the Economic Secretary to the Treasury and their teams for their engagement with us on this short but complex Bill. The input from the Ministers and their teams has unravelled a lot of that complexity and answered a lot of questions. We broadly support the Bill The need to replace Libor has been well flagged. As the Minister has noted, the FSB made it clear in 2014 that the continued use of Libor represented a potentially serious systemic risk. It made this judgement in response to cases of what it described as "attempted manipulation" of the rate "and declining liquidity in key interbank unsecured funding markets." The imminent end of Libor has already been well flagged, at least to major players. Ideally, the Ibors would be replaced by risk-free rates, such as SONIA, but it has been obvious for some time that there would be existing, continuing contracts that would be unable to transition easily or in a timely fashion—or, perhaps, at all—to the new RFRs As the Minister has explained, the provisions of this Bill enable the FCA to address the problem. It gives powers to the FCA to allow, for some as yet unspecified categories of tough legacy contracts, continued use of synthetic Libor after the demise of the index at the end of this year. The Bill also provides some narrowly drawn legal protections for the administrators of the synthetic Libor It is worth noting that the Bill does not include in its scope the synthetic Libor mechanism itself. There has been no parliamentary scrutiny of this mechanism. Consultation is not the same as, or equivalent to, parliamentary scrutiny. It is regrettable that Parliament has not had the opportunity to scrutinise this mechanism and its likely consequences, or any alternative mechanisms, such as the linear transition mechanism mentioned in paragraph 28 of the FCA’s recent technical note. There is a very large gap in our scrutiny system where financial affairs are concerned. The exercise of unscrutinised power by the FCA illustrates the need, once again, for a dedicated financial affairs select committee The measures in the Bill are intended to produce an orderly end to the existing regime and to provide a temporary bridge for some exceptional contracts. I have been impressed by the depth and quality of the work that has gone into preparing for transition and for creating the synthetic Libor. I have no issues with the fundamentals of the proposals, but some questions remain, and I would welcome the Minister’s clarifications The first question is to do with timing. Why was the end of this year chosen as the cut-off point? What discussions have we had with the US authorities about synchronising our moves away from Libor? Would it not have been better and simpler to act together and give more time for contracts to be transitioned, reducing the number of those moving to a synthetic Libor substitute My second question is also to do with timing—in this case, the timing of the formal announcement of who may use synthetic Libor. As things stand, the FCA’s consultation on the matter does not close until the end of this month. Only after that will the FCA issue a formal policy paper setting out the rules for qualifying for the use of the synthetic Libor. That is two months before the general expiry of Libor—not long to prepare if the rules do not allow your contract to qualify. Why has it been left this late When I asked the Minister about this in our meeting on Monday, he pointed to the fact that the enabling powers in the Financial Services Act 2021 became active only in April. But we had been preparing this transition for long before that, and the Government cannot seriously have expected their proposals to have been overturned during the passage of that Bill. Surely, it would have been possible to at least have the consultation ready to go as soon as the Act was passed, or even to consult as it was being debated—something the Government have done in the past. I know the FCA has signalled that the rules may allow wide but time-limited scope, but can the Minister reassure us that it does not foresee the disruptive exclusion of significant tough legacy contracts from the synthetic regime My next question is about the absence of safe harbour provisions. The narrow immunity on offer to the administrator may not, of course, prevent an outbreak of lawsuits. New York has dealt with this problem more comprehensively than we propose to do by adopting safe harbour provisions. During the Report stage of the Financial Services Bill 2021, the noble Baroness, Lady Noakes, who I am glad to see in her place, proposed, in Amendment 6, such a safe harbour provision. The Government rejected the amendment, and the Minister explained why, saying: "Amendment 6 may seem to solve those problems by seeking to give the Treasury powers to make regulations providing for contract continuity and safe harbour through secondary legislation, having had more time to consider these matters. The Government are of the view that, if legislation were needed to address this, it should be in the form of primary legislation. Further legislation providing for safe harbour, as proposed by these amendments, while consistent with the provisions already in the Bill, may be considered by some parties to represent a significant intervention in the contractual rights of parties using critical benchmarks. Primary legislation would therefore be preferable, to provide all parties with an appropriate level of transparency. Crucially, given the volume and value of contracts impacted, making such a provision in secondary legislation would carry a risk of legal challenge to the Government’s exercise of their powers. Any such challenge could bring further uncertainty and disruption, which is precisely what these amendments are seeking to mitigate."—[Official Report, 24/3/21; col. 923.] That was not a rebuttal of the notion of safe harbour. It was simply an explanation of why primary legislation would be a better way of achieving it. Well, we are now discussing primary legislation. Did we consider using safe harbour provisions similar to those adopted in New York and, if we did, why we chose not to use them? Did Her Majesty’s Government identify any benefits provided by the safe harbour approach that would not accrue under our scheme Next, there is the issue of a possible cliff edge at the end of the year. In the first Peers’ meeting with the Economic Secretary to the Treasury, we were told that there may be a difference of 10 basis points between the old Libor and the first runs of the new synthetic Libor. The very helpful FCA technical note on the end of year impact says in paragraph 23: "We do not know precisely or with certainty what the difference between synthetic LIBOR on 4 January 2022 and panel bank LIBOR on 31 December 2021 will be." Does this not raise the possibility of significant market disturbances and disputes? The mechanisms proposed for generating synthetic Libor outputs have been published by the FCA in its draft notice of 29 September. Can the Minister say whether these mechanisms for determining synthetic Libor can be adjusted to produce a smoother, less step-like transition, if this looks to be desirable? If that cannot be done, can the Minister say what reactions he expects in the markets as a result of a variation of 10 basis points or more at the beginning of the new year. Can he also say what a realistic upper bound of this differential might be I have one further question: will there be some contracts which will never be able, or will decline, to transition to RFRs? If there are, what characterises them? Do we have any idea of how many there might be in number and value, and what does the FCA propose to do about them I realise that I have asked a lot of questions. I entirely understand if the Minister does not have time to answer them all this evening, but I would be very grateful for a written response before we get to Committee.