The Report reached three fundamental conclusions:
- There is a clear case for a comprehensive reform of LIBOR, rather than replacing the benchmark with a new one.
- There should be strict and detailed processes for verifying LIBOR submissions against transaction data. LIBOR should only be published for those currencies and tenors for which there is sufficient transaction data to corroborate the LIBOR submission.
- Market participants should continue to play a significant role in the production and oversight of LIBOR.
Based on these conclusions, the Report sets out a ten point plan for the reform of LIBOR. This plan includes proposals for governance and institutional reform, regulation, technical changes and contingency planning.
Key points include the following:
A. The transfer of responsibility for LIBOR from the BBA to a new administrator who would be responsible for compiling and distributing the rate as well as providing credible internal governance and oversight. As part of its governance and oversight of the rate, the new administrator would be required to fulfil specific obligations as to transparency and fair and non-discriminatory access to the benchmark. It would also, as a priority, introduce a code of conduct for submitters.(1)
B. LIBOR submissions and administration to be made 'regulated activities' under the Financial Services and Markets Act 2000 and manipulation of LIBOR to be made an offence under Section 397 of the Financial Services and Markets Act 2000.
C. LIBOR for certain currencies and tenors to be phased out. In particular:
- publication of rates for Australian dollar, Canadian dollar, Danish krone, New Zealand dollar and Swedish krona should be discontinued;
- publication of LIBOR for four, five, seven, eight, ten and eleven months should be discontinued; and
- continued publication of overnight, one week, two weeks, two months and nine months should be re-considered.
The effect of this would be to reduce the number of LIBOR benchmarks from 150 to 20. The recommendation is that these rates would be phased out over a 12 month (or potentially shorter) transition period. Work towards implementing this recommendation should be carried out by the BBA.
D. New LIBOR submission guidelines (using available data to inform and corroborate the LIBOR submissions). The guidelines will also provide that LIBOR submissions should be withheld from publication for at least three months to reduce the potential for submitters to manipulate the market.
E. A broader range of banks should be encouraged (and potentially compelled) to participate in the LIBOR compilation process.
F. Market participants should be encouraged to consider whether LIBOR is the most appropriate benchmark for their transactions and whether standard contracts contain adequate contingency provisions should LIBOR not be available.
The FSA expects firms to take appropriate steps to prepare for the impact of these proposals and a failure to do so is likely to be considered a breach of the FSA's governance requirements set out in its systems and controls handbook (SYSC) and General Principle 3, that firms must organise their affairs properly with appropriate systems and controls.
The key areas of contractual focus for financial markets participants following the publication of the Report are likely to include the following:
- contractual due diligence to:
- establish the range of LIBOR definitions and benchmarks in their transactions;
- review of LIBOR definitions to evaluate the adequacy of the relevant "fallback" provisions to cover planned and potential changes to LIBOR and the possibility of LIBOR not being produced. The "fallback" provisions should also appropriately and effectively cover the non-publication of the BBA screen rate. Banks may also consider using a definition of LIBOR by reference to the relevant Reuters page rate, rather than the BBA's screen rate, if they are not already doing so;
- identify whether any transactions contain LIBOR currencies or tenors which are to be discontinued; and
- although not arising out of the Report itself, as a matter of prudence market participants will also wish to ensure that precedents, templates, standard form agreements are amended to include a provision for negative LIBOR, as recommended by the Loan Market Association in September 2011;
- contingency planning, in conjunction with any relevant market associations, in relation to the proposed and potential future changes to LIBOR and other benchmarks, and the effect these changes or other longer term disruption or discontinuance of LIBOR or such benchmarks may have on existing definitions and contracts including the issues identified below;
- considering the effect (if any) on contracts of the transfer of the BBA's role as LIBOR administrator to a new administrator;
- considering whether risk factors and disclosures should be included in term sheets and contracts to cover LIBOR and benchmark related issues; and
- assessing the effect of (if any) of the proposed changes on proprietary indices.
The Loan Market Association is currently in the process of discussing the issues arising out of the Report in order to compile its own set of recommendations, which have yet to be published. Meanwhile it has published an amended LIBOR definition in its primary template facility agreements to deal with the perceived threat of negative LIBOR rates being published.
If you have any questions on this alerter or would like to discuss how the Report could affect your organisation, its practices and documentation (both existing deal documentation and your standard documents) please do not hesitate to get in touch with a member of the Field Fisher Waterhouse LLP Finance Group. We would be pleased to assist you.
(1) On 17 October 2012 Greg Clark, the Financial Secretary to the Treasury released a written ministerial statement in which it was confirmed that Baroness Hogg has agreed to chair a panel of independent experts tasked with identifying an appropriate successor to the BBA as LIBOR administrator.
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