Libor to become third-country benchmark under no-deal Brexit

Libor would lose its authorised benchmark status in the European Union in a no-deal Brexit scenario, leaving nine months for the reference rate’s administrator to reapply as a third-country provider, a lawyer has warned.

“[If there’s not a deal] then the market is faced with the prospect at the end of March next year of UK-based benchmark administrators who are on the EU’s benchmark register suddenly having that authorisation effectively [disappear],” says Peter Green, a senior lawyer at Morrison & Foerster in London.  

Under Europe’s Benchmark Regulation (BMR), from January 1, 2020, EU entities can only reference authorised financial benchmarks in new trades. The various currency Libor rates, administered by the UK-based Ice Benchmark Administration (IBA), were authorised by EU regulators earlier this year.

However under a no-deal Brexit scenario, which sees the UK treated as a third country with no equivalence, come March 29, 2019, Libor would cease to be authorised and listed on the EU’s benchmark register, meaning it would be unauthorised under the BMR.

Under the benchmark rules, only fixings that are on the register can be used for pricing financial products. If Libor was unable to be reauthorised as a third-country benchmark by the end of 2019, it would cause significant disruption for EU users and any counterparties trading with them.

“Considering the number of transactions that reference Libor and other benchmarks provided by UK administrators, the impact of those suddenly not being able to be provided across the EU is pretty unthinkable” says Green. “It’s not in the EU’s interest to suddenly lose very important market benchmarks.”

Libor is categorised as one of Europe’s three most important benchmarks, alongside Euribor and Eonia. These three fixings are designated as “critical” by the European Securities and Markets Authority. An Esma spokesperson confirmed that critical benchmarks can only be provided by administrators located within the European Union. So once the UK formally leaves the bloc, Libor loses its critical benchmark status.

“Any third-country benchmark cannot be a critical benchmark,” the spokesperson confirms.

When a benchmark is deemed critical by European authorities, it gives the relevant national competent authority overseeing a benchmark administrator – in Libor’s case, the Financial Conduct Authority – the power to compel banks to continue to submit quotes to keep it functioning.

It’s not in the EU’s interest to suddenly lose very important market benchmarks

Peter Green, Morrison & Foerster

The FCA has already reached a voluntary agreement with the 20 Libor panel banks to continue providing quotes until at least the end of 2021. Although the FCA has not yet invoked its powers of compulsion, it is unclear whether the UK authority will retain these powers in the event of a no-deal Brexit. Upon leaving the EU, most existing European law converts into UK law according to transitional arrangements, but the FCA may need to re-designate Libor as a critical benchmark to retain its powers of compulsion.

Green says it’s likely the UK regulators will find a way to keep these powers. “It is almost certain that, whether or not there is a deal, UK financial regulation will preserve the FCA’s powers [of compulsion] over Libor for the time being,” he says.

It’s also understood that IBA will retain its authorisation in the UK after a no-deal Brexit, meaning UK users will still be able to use the benchmark.

The FCA and IBA declined to comment.

Three avenues for approval

While the prospect of Libor failing to gain EU reauthorisation as a third-country benchmark is slim, given the financial stability risks involved, the approval process isn’t necessarily straightforward.

There are three potential routes to gaining authorisation, the first being equivalence. Article 30 of the BMR requires the UK to pass similar benchmark legislation to the EU in order to seek an equivalence decision from European regulators.

As most EU law will be replicated in UK law on the day of withdrawal, equivalence seems the easiest of the three routes for UK benchmark administrators to take. But there are complications.

“[The UK also] has to be recognised as equivalent by the EU Commission and various co-operation arrangements have to be put in place,” says Morrison & Foerster’s Green.

“In theory it could be done quite quickly because, as long as the EU is satisfied that the UK is still applying rules very similar to those under the benchmark regulation, then it should be a straightforward process. The EU Withdrawal Act will have the effect of preserving the terms of the [BMR] in the UK once Brexit occurs so the UK will be de facto equivalent,” he adds. “But as we know, politically, some members of the EU have concerns as to the extent that equivalence should be used to enable UK firms to access the single market after Brexit.”

Green warns that “whilst logically you would have thought that the EU could move very quickly to make the UK equivalent in relation to benchmark regulation, it doesn’t have any obligation to do so in any particular timeframe”.

With MP Nicky Morgan, chair of the UK’s Treasury Select Committee, telling delegates at Isda’s annual Europe conference in London earlier this month that the chances of a “catastrophic” no-deal Brexit were more than 50%, there are concerns that UK-based benchmark administrators wouldn’t be able to obtain authorisation via the equivalence route before the 2019 deadline.

According to Green, as “almost no jurisdiction” currently has an equivalent benchmark regime to the EU, the likelier route to re-authorisation is recognition, where under Article 32 of the BMR, third-country benchmark administrators can continue providing Libor if they’re granted recognition by a competent authority in the bloc.

As with equivalence, though, this method isn’t as easy as it sounds. Benchmark administrators would have to allocate a suitable country as their so-called “member state of reference”, apply to the relevant authority to recognise them, and appoint a legal representative in that member state.  

“As far as I’m aware I don’t think any third-country administrator has yet gone through that process so it’s a little bit uncertain as to how it all works in practice,” says Green.

The timeframe for this process may also present problems. The BMR states that competent authorities have 90 working days from receiving a UK-based benchmark administrator’s application for recognition to formally verify or reject it. If UK-based providers haven’t already started the process of meeting the requirements for recognition, then they may be scrambling for authorisation in time for the 2019 deadline.

The third and final option, under Article 33 of the regulation, is endorsement – which sees a non-EU administrator being able to register a third-country benchmark, if that benchmark is endorsed by an authorised benchmark administrator within the EU.

In order to achieve this, the authorised EU benchmark administrator will have to apply to its local authority for endorsement of the UK-based provider’s benchmarks – which could potentially be achieved through a commercial arrangement that would see the EU benchmark administrator providing this service.

While this potentially seems like the quickest route for benchmark administrators such as IBA to take, Green says it is even less clear how endorsement works in practice compared to the other two options on the table.

For example, Article 33 stipulates that the EU benchmark administrator in question has to be able to demonstrate that it will have a “well-defined role” within the accountability framework of the UK-based administrator, and that it will supervise the administration of UK-based benchmarks on an “ongoing” basis.

As part of this, the EU administrator therefore needs to prove to its competent authority that it has the necessary capabilities to monitor the provision of a third-country, UK-based benchmark.

Some benchmark experts thought IBA might take this approach by opening an EU subsidiary and endorsing its London-based Libor benchmarks, but it’s understood IBA will not be creating any European entities.

Editing by Alex Krohn

This article first appeared on Risk.net