PARLIAMENTARY DEBATE
Critical Benchmarks (References and Administrators’ Liability) Bill [Lords] - 18 November 2021 (Commons/Commons Chamber)

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.

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?

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.

I thank my very good friend the Minister for allowing me to intervene. He understands all this, and I understand some of it, but not much. I speak, however, as someone who is concerned. If we are moving away from LIBOR, is such a move likely to result in a greater cost to those who wish to borrow money?

As ever, my right hon. Friend makes a reasonable point, and I will come on to address the potential divergence, and the implications of the synthetic methodology for the existing rate that we are about to institute and protect in the Bill. In short, there is a lot of volatility in the market, and it is difficult to be fully confident in determining the exact quantum of any difference between where the synthetic rate would get to and the existing outgoing LIBOR rate based on the panel banks. I will address that point more substantively in further stages of the Bill.

In the case of LIBOR, the FCA has indicated that it will designate it using that provision in the Financial Services Act at the end of 2021, when the panel banks will cease making submissions to the administrator. The FCA has announced that it will use its powers to compel the continued publication of certain LIBOR settings, using a revised methodology referred to as “synthetic LIBOR”. The FCA has done that so that tough legacy contracts can continue to function, protecting against the market disruption that would arise were the benchmark to cease permanently at the end of this year with nothing in its place. It is important to emphasise that the synthetic rate is a temporary safety net that will be available for at most 10 years, and only for legacy contracts that have not been able to move away from LIBOR in time for the year end. It is not intended to replace LIBOR in the long-term, and new financial contracts will not be allowed to reference the synthetic rate.

The Bill provides important legal clarity for users of the synthetic LIBOR rate. Clause 1 provides explicitly that LIBOR referencing contracts can rely on synthetic LIBOR. That is covered in proposed new articles 23FA and 23FB which the Bill would insert into the benchmarks regulation. Specifically, where the FCA imposes a change in how the benchmark is calculated, such as a synthetic methodology, the Bill makes clear that references to the benchmark in contracts also include the benchmark in its synthetic form. In the case of LIBOR wind-down, where a contract says “LIBOR”, that should be read as referring to synthetic LIBOR, so that there is effective continuity. That will provide legal certainty for contracts that will continue to refer to LIBOR after the end of 2021.

The Bill also provides a narrow immunity for the administrator of a critical benchmark for action it is required to take by the FCA. That includes where it is required to change how a critical benchmark is calculated, such as a change in the benchmark’s methodology. That will protect the administrator from unmerited and vexatious legal claims. The Government have introduced this in the narrowest way possible. It does not protect the administrator to the extent that it can act with discretion; it protects it only to the extent that it is acting purely on a direction from the FCA. The Bill does not in any way change the ability to challenge the FCA, and its decisions on setting a synthetic methodology are subject to challenge on the usual public law grounds. That means that provision is enabled for legal challenge, but the existence of the synthetic rate as a continuity to LIBOR on the panel bank basis is not grounds for legal challenge.

The UK has one of the most open, innovative and dynamic financial services sectors in the world. The Bill reaffirms the Government’s commitment to protecting and promoting the UK’s financial services sector. As the home of LIBOR, the United Kingdom has a unique and crucial role to play in minimising global financial stability risks and disruption to financial systems from the wind-down of LIBOR. The Bill forms part of a significant programme of work by the Government and regulators to support the global market-led transition away from LIBOR, as indicated by the FSB decision in 2014. It supports the integrity of financial markets, and in doing so underlines our reputation as a custodian of a global financial centre.

The LIBOR transition is the responsibility of the FCA. It is important to remember that LIBOR is primarily the preserve of sophisticated financial operators, not retail investors. The vast majority of LIBOR contracts are derivatives. Those are sophisticated financial products, the vast majority of which will transition away from LIBOR voluntarily. Synthetic LIBOR will be used only by a limited set of contracts and as a last resort. The market-led, voluntary transition of contracts away from LIBOR to robust alternative rates has been ongoing for years, and the success of that transition means that the vast majority of contracts will not need to use the synthetic rate at all. Where synthetic LIBOR is used in contracts, it is appropriate that the FCA takes technical decisions on the methodology. Indeed, our regulatory system often sees independent bodies empowered to produce calculations that reflect and influence economic reality, such as the Bank of England setting base rates.

A question raised on Second Reading from the Opposition Benches in the other place concerned whether the Government would consider giving compensation to consumers who lose out from synthetic LIBOR—that echoes the question from my right hon. Friend the Member for Beckenham (Bob Stewart). We do not know at this stage what the difference will be between panel bank LIBOR and synthetic LIBOR on the day synthetic comes in, but it is clear that any change will be well within the range of change in the rate that could reasonably be expected, based on what LIBOR has been historically.

The replacement rate is based on a five-year average, so in the medium term consumers should enjoy similar returns, but with less risk of day-to-day changes in how their rate is calculated. It is therefore not at all clear that consumers will lose out from this change, or that there is a case for compensating the subset of consumers affected. The Government would not compensate mortgage holders for a change in the Bank rate, for example.

There are two issues here. There is the difficulty in determining what that quantum of difference could mean, because there is an evolving move off the LIBOR rate even at this stage. We also have the situation where, in essence, such rates and benchmarks are used in different ways. Mortgage holders would have the opportunity to go their provider and ask to move another rate, for example the Bank rate.

I reassure the House that consumer interests have been factored into all decisions relating to LIBOR wind-down. In particular, the FCA has considered how to address concerns that the synthetic methodology may result in a rate which is higher than the current LIBOR rate. The FCA has taken a rigorous and careful approach to making the decision on the synthetic methodology, resulting in a decision that is entirely in line with the global consensus, among both industry and regulators internationally. This has been a careful and deliberate process, and I commend both my officials and the professionals at the FCA for the work they have undertaken.

The FCA’s synthetic rate will seek to provide a reasonable and fair approximation of what LIBOR would have been had it continued to be based on panel bank contributions, while removing a major factor in the volatility of the rate. That is to the benefit of parties to contracts referencing LIBOR, who will no longer be exposed to perceived changes in bank creditworthiness or liquidity conditions in wholesale funding markets. The alternative is having no rate at all, or being put on an unsuitable fall-back rate that may well be designed for a different situation, such as a short-term problem with publishing LIBOR. The Bill supports the wind-down process by ensuring that contracts will remain able to function if they are not able to transition to an alternative rate in time.

The Government have worked at pace to develop this legislation, carefully considering responses to the consultation and the complex range of contracts that reference critical benchmarks. As I have said, the FCA has confirmed the process to put in place a synthetic methodology by the end of this year. The Government will continue to engage with regulators to ensure a smooth transition.

I want to respond to the point made by the hon. Member for Glenrothes (Peter Grant) in his intervention on the number of mortgage holders. There is some speculation over how many mortgage holders will be affected. Some estimates say it could be 200,000, or 1.8% of the mortgages held in the UK, about half of which would be buy-to-let mortgages and the other half residential mortgages. However, the estimates I have received from industry suggest it would be significantly less than that, and a diminishing number. I think that that is the best I can give the hon. Gentleman.

I hope that I have provided the House with the background to the Bill, an explanation of its provisions and an update on the broader work being undertaken by regulators on the LIBOR transition, and that we can debate the provisions in the Bill in a constructive manner and deliver this vital legislation.

I will conclude by recognising that this is an unusually complex and technical Bill. I would not want to be in any way patronising to the House, but I want to be open to questions on it at the next stage. However, I hope I have satisfied the House in explaining the principles and narrative the Government have around this Bill.

Forgive me for intervening yet again, but, for the normal person, does synthetic LIBOR and 12 basis points mean a 12% increase on what he or she might pay?

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.

I want to address thoroughly all the points raised by the right hon. Member for Wolverhampton South East (Mr McFadden) and the hon. Member for Glenrothes (Peter Grant) about legal certainty, the temporary nature of this provision, and concerns about what will happen to the population of mortgage holders.

This is clearly a technical Bill. The Government are taking clear action to ensure that contracts that make reference to LIBOR, and that cannot transition before the end of the year, can continue to function. It is vital that the Government take the necessary steps to make the wind-down of LIBOR as smooth and orderly as possible, given the number of contracts that refer to it.

I was asked why people are on LIBOR mortgages. Customers who hold LIBOR-referencing mortgages are, and should continue to be, encouraged to speak to their lender to switch to an alternative rate. The FCA has been very clear with lenders that they must be able to demonstrate that they have fulfilled their duty to treat customers fairly where they transition them to a replacement rate. The Bill will not do anything to restrict consumers’ ability to bring mis-selling claims if they arise.

Let me address synthetic methodology—a term that refers to the methodology that the FCA would impose on the administrator to provide for the continuity of a LIBOR-setting function for the benefit of these tough legacy contracts. The hon. Member for Glenrothes cited the figure of £472 billion, which was the FCA’s estimate on 29 September. The synthetic methodology will seek to replicate, as far as possible, the economic outcomes that would have been achieved under LIBOR’s panel bank methodology, but without the need for panel bank submissions.

The FCA has always made it clear, however, that the synthetic methodology will not be representative of the underlying economic reality that LIBOR seeks to measure. Parties to contracts and agreements that make reference to the benchmark should seek to transition to suitable alternative reference rates where possible. That process will continue. There is a lot of speculation about the numbers, but it is impossible to verify them at this stage.

Reference has been made to the differences in rate between panel bank LIBOR and synthetic LIBOR. We have given responsibility for the synthetic rate methodology to the FCA in consequence of the Financial Services Act. Its approach will provide a fair and reasonable approximation of what LIBOR would have been if it had continued to be calculated under the previous panel bank methodology, while removing a large factor in the rate’s volatility. That will be to the benefit of those who have contracts that refer to LIBOR.

It is important to note that, even in the past few weeks, the LIBOR rate has been volatile. There have been some days when the synthetic methodology would have produced a lower rate than panel bank LIBOR, and other days when it would have been slightly higher. That illustrates clearly that it is not sensible to speculate about a change in the rate on day one of the change in methodology. It is impossible, really, to create an enduring and certain difference.

Given the interest in how the rate works, let me explain that sterling synthetic LIBOR will be calculated using SONIA—the sterling overnight index average—with the addition of the International Swaps and Derivatives Association five-year median credit spread. ISDA, the trade association, has played an important role in consulting the market to arrive at consensus on key elements of the LIBOR transition.

Let me briefly address the concern about how we got to this point. There was iterative consultation as widely as possible with the industry to develop consensus. As for the question of why the legislation was needed and whether we will need to do it again, this provision was based on legal advice and is intended to address concerns raised by industry about the robustness of the synthetic methodology. The methodology involves a five-year median for the credit spread, which was selected following that industry consultation, to avoid manipulation. It is important to remember that LIBOR is a forward-looking interest rate benchmark, and to replicate its economics the synthetic methodology will be calculated using the SONIA term rate.

The issue of the 12 base points was raised. The synthetic LIBOR will be 12 points higher than SONIA, not LIBOR. The difference between LIBOR and synthetic LIBOR will depend on the LIBOR and SONIA rates on the relevant day. Again, it is impossible to fully verify and quantify the difference, in terms of those that are not rolled off to another rate and the way in which the rates will perform in reality.

The right hon. Member for Wolverhampton South East referred to what is commonly known as the “safe harbour” provision. Some industry stakeholders have called for an express legal safe harbour like that put in place by the New York legislature. The Bill makes clear that references in contracts to a critical benchmark include the benchmark in its synthetic form. Furthermore, by providing in the Bill that contracts are to be interpreted as having always provided for the synthetic form of the benchmark to be used once the benchmark existed in that form, the Government have sought to address the risk of a party’s arguing that the use of the synthetic benchmark constitutes a material change to a contract, or even that it has frustrated the purpose of the contract.

It is the Government’s view that this Bill comprehensively addresses the risk of legal uncertainty in a proportionate way, while not interfering with other valid claims. We considered approaches taken in other jurisdictions, notably New York, but as a matter of policy the Government do not think it would be appropriate or proportionate to prevent parties’ ability to seek legal redress via the courts for other issues that may arise under affected contracts. A contract could be entered into and there could be a legal dispute over how it had come about, separate from the issue of the LIBOR dependency. We thought that this was the appropriate way to proceed, because the Bill was never about withdrawing the legal rights of individuals.

This is an important Bill. Now that the FCA has confirmed the process to wind down LIBOR by the end of this year, the Government are committed to having this legislation in place to mitigate the residual risk of litigation and disruption resulting from the LIBOR wind-down in the UK. We believe that it is vital to the protection of consumers and the integrity of UK markets.

Question put and agreed to.

Bill accordingly read a Second time.