(a) The EU Benchmarks Regulation—Setting the Stage
Regulation (EU) No. 2016/1011 of the European Parliament and of the Council of June 8, 2016 and related delegated regulations (together, the “Benchmarks Regulation”) applied, in part, to critical benchmarks from June 30, 2016 and, substantially, to all benchmarks used in the European Union (“EU”) from January 1, 2018, subject to certain transition provisions discussed in more detail below, and regulates "contributors", "administrators" and "users" of benchmarks in the EU.
Under the Benchmarks Regulation, an administrator is any natural or legal person that has control over the provision of a benchmark. In this context, ICE Benchmark Administration ("IBA") is the current administrator of the London Interbank Offered Rate ("LIBOR"). Under the Benchmarks Regulation, a benchmark administrator such as the IBA located in the EU must apply to its relevant competent authority for authorization if it provides or intends to provide indices for use as benchmarks in the EU. In addition, a benchmark administrator must, subject to certain transitional provisions in the Benchmarks Regulation, register the benchmarks it administers in the European Securities and Market Authority's ("ESMA") register of administrators pursuant to Article 36 of the Benchmarks Regulation.
Absent such an authorization for IBA and the registration of LIBOR in ESMA's register, EU supervised entities (which include EU regulated investment firms) would cease to be able to "use" LIBOR as a benchmark, which would include, among other actions (i) issuing floating rate, index-linked and other bonds referencing LIBOR; (ii) determining, as calculation agent (or in any other role), the amount payable on any such bond; or (iii) providing a borrowing rate calculated as a spread or mark-up over an index or combination of indices. Supervised entities that use a benchmark such as LIBOR must, in addition, produce robust written plans setting out the actions they would take if the benchmark should materially change or cease to be provided. This requirement explains why European calculation agents have, for some time, advised issuers of bonds linked to benchmarks such as LIBOR to include detailed benchmark discontinuation provisions in the terms of their bonds and have requested that their requirement to participate in their traditional roles as agents and calculation agents on such bond issues be qualified at all times by their need to comply with the Benchmarks Regulation.
For these reasons, IBA has been authorized by the United Kingdom's Financial Conduct Authority under the Benchmarks Regulation, and LIBOR has been registered in ESMA’s register since April 27, 2018.
(b) The Impact of Brexit on LIBOR
The Benchmarks Regulation currently applies in the United Kingdom as an EU member state, and the authorization of IBA under the Benchmarks Regulation applies to IBA as an EU entity.
As you are aware, the United Kingdom will leave the EU at 11:00 p.m. (London time) on March 29, 2019 (the so-called “exit date”) and, absent any agreed transitional arrangements in a withdrawal agreement between the United Kingdom and the EU, IBA's authorization under the Benchmarks Regulation will cease to be valid from 11:00 p.m. on this date.
The cessation of IBA's authorization will occur on the exit date despite the fact that the UK government's treasury department ("HMT") has signaled, by means of the publication of draft regulations in the form of the Benchmarks (Amendment) (EU Exit) Regulations 2018, that it will "domesticate" into UK law an equivalent domestic regime to the Benchmarks Regulation (which is part of the UK government's so-called "onshoring" approach to European financial services regulation) because the United Kingdom and its future domestic regime will not be subject to EU law, regulation or regulatory scrutiny and may diverge from the European position under the Benchmarks Regulation at any time in the future.
(c) The Transitional Period and Future Solutions Available to the IBA
On the basis of the above, UK-based benchmark administrators (including IBA) will need to consider the equivalence, recognition and endorsement routes that are available under the Benchmarks Regulation for third country administrators so as to enable their benchmarks to continue to be used in the EU and by EU market participants.
From the exit date, UK-based benchmark administrators can, however, benefit from Article 51(5) of the Benchmarks Regulation that provides that benchmarks of non-EU-based benchmark administrators can continue to be used in the EU if already used in the EU as a reference for financial instruments (and can be added as a reference to new financial instruments) up until December 31, 2019.
Moreover, though an equivalence determination of the EU Commission (one of the routes referred to above) pursuant to Article 30 of the Benchmarks Regulation is not automatic (and will, among other items, involve the United Kingdom entering into various cooperation arrangements with the EU relating to exchange of information on the administrator and its compliance with law), it is hoped that the facts that IBA and LIBOR are currently authorized and registered within the EU and should, from March 29, 2019, be regulated by a domestic regime that is substantively the same as the Benchmarks Regulation, will assist the EU Commission in making a swift determination that LIBOR is equivalent for the purposes of the Benchmarks Regulation.
There are, however, political risks to overcome to a granting of equivalence for LIBOR by the EU—with reluctance among some member states of the EU to allow the United Kingdom and its businesses to use equivalence rights under the Benchmarks Regulation (and other European financial services legislation) to gain backdoor access to the EU single market.
If equivalence status is not available to LIBOR, then Article 32 of the Benchmarks Regulation provides the alternative route of recognition for LIBOR—which would involve IBA obtaining prior recognition by a "member state of reference" in the EU. Such recognition would require IBA to have legal representation in the EU through which regulatory oversight of LIBOR would be affected by an EU competent authority. The EU legal representative would be required to carry out oversight responsibilities and would effectively be accountable for the provision of LIBOR within the EU. A cooperation agreement would also need to be in place between the relevant EU member state and the United Kingdom. It is worth noting that this recognition route is, currently, untested by non-EU benchmark administrators and it is by no means certain that IBA could obtain a recognition decision for LIBOR by the end of 2019.
Lastly, EU administrators are able to endorse non-EU benchmarks pursuant to Article 33 of the Benchmarks Regulation where the EU administrator has a clear and well-defined role in the accountability framework of the third country administrator and can monitor the provision of the benchmark and where there is an objective reason to provide the benchmark in a third country and endorse it for use in the EU. The EU endorsing administrator must remain fully responsible for the third country benchmark and its compliance with the Benchmarks Regulation. In order to achieve this endorsement, the authorized EU benchmark administrator will have to apply to its local authority for endorsement of the non-EU administrator's benchmarks—which could potentially be achieved through a commercial arrangement that would see the EU benchmark administrator providing this service. Though this route would allow IBA to establish an EU subsidiary that could complete this role in the EU for IBA, it is currently understood that IBA does not intend to establish any such subsidiary.
If LIBOR is unable to be used by EU supervised entities from January 1, 2020, this would cause significant disruption for the European and international capital markets.
Accordingly, though the consequences of Brexit for IBA and LIBOR remain currently uncertain, it would not seem in the interest of the EU to lose the use of this critical benchmark in its markets.
We will keep you apprised of developments in this area during the course of 2019.