Climate-related disclosures for issuers: further steps towards mandatory requirements?

In November 2020, the UK Joint Government Regulator TCFD Taskforce published its “roadmap towards mandatory climate-related disclosures”, which set out a vision for the next five years. As an initial step towards fulfilling that vision, in January 2021, the new Listing Rule 9.8.6(8) (LR) came into force. The LR requires premium-listed issuers, in their periodic reporting, to publish disclosures in line with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations on a ‘comply or explain’ basis. However, the Financial Conduct Authority (FCA) has recognised that some issuers may need more time to deal with modelling, analytical, metric or data-based challenges.

This flexibility in the new LR’s compliance basis reflects the challenges and evolving experiences with working on data and metrics in the context of climate risk. Key stakeholders should now be redoubling their efforts to meet the challenges and with the promise of further TCFD guidance on data and metrics later this year and the recent launch of a Department for Business, Energy and Industrial Strategy (BEIS) consultation seeking views on proposals to mandate climate-related financial disclosures in line with the TCFD recommendations from 6 April 2022, the step to a mandatory climate-related disclosure regime may be closer than initially envisaged.

In light of the ever-evolving regulatory landscape, it is important issuers continue to monitor the impact of any changes to their disclosure requirements and to consider what, if any, litigation risks may arise (particularly, under s90 FSMA, s90A FSMA, or in common law or equity) in connection with their climate-related disclosures.

The key developments on data and metrics, as well as the key proposals from the BEIS consultation, are examined below. We also consider what these developments and proposals mean for issuers in terms of regulatory reporting requirements.

Climate Financial Risk Forum

Following its fifth quarterly meeting in November 2020, the Climate Financial Risk Forum (CFRF) noted the importance of progress in the development and understanding of climate data and metrics. In light of this, the CFRF announced that all of its working groups will focus on climate data and metrics in the next phase of work. This is a shift from the CFRF’s previous approach of allocating different focus areas to its working groups.

TCFD Financial Metrics Consultation

The TCFD has this month published a summary of the responses to its ‘Forward-looking Financial Metrics’ Consultation, which was conducted between October 2020 and January 2021. The consultation aimed to collect feedback on decision-useful, forward-looking metrics to be disclosed by financial institutions. The TCFD solicited feedback on specific metrics and views on the shift to, and usefulness of, forward-looking metrics more broadly.

46% of the 209 respondents were financial services firms from around the world, and over half of the respondents were EMEA based, with just over a quarter from North America.

These findings will inform the work on metrics and targets which the TCFD plans to tackle in 2021. The TCFD announced that it will publish broader, additional draft guidance for market review and consideration later this year.

BEIS Consultation

BEIS launched a consultation this month on mandating climate-related disclosures by publicly quoted companies, large private companies and LLPs. The consultation proposes that, for financial periods starting on or after 6 April 2022, certain UK companies with more than 500 employees (including premium-listed companies) be required to report climate-related financial disclosures in the non-financial information statement which forms part of the Strategic Report. Such disclosures are required to be in line with the four overarching pillars of the TCFD recommendations (Governance, Strategy, Risk Management, Metrics & Targets).

BEIS has stated that the proposed rules are intended to be complementary to the FCA’s requirement that premium-listed companies make disclosures in line with the four pillars and 11 recommended disclosures of the TCFD. BEIS proposes to introduce the new rules via secondary legislation which will amend the Companies Act 2006.

The Financial Reporting Council will be responsible for monitoring and enforcing the proposed rules, while the FCA will supervise and enforce disclosures within the scope of the LR.

The consultation is open until 5 May 2021.

Regulatory reporting requirements

The new TCFD guidance, once published, is likely to feed into the LR requirements. The new LR expressly refers to the TCFD Guidance on Risk Management Integration and Disclosure and the TCFD Guidance on Scenario Analysis for Non-Financial Companies published in October 2020. Additionally, the FCA’s Policy Statement dated December 2020, which accompanied the new LR, stated that the FCA would be considering how best to include references to any further TCFD guidance in the FCA Handbook Guidance. This is likely to be achieved through the use of the FCA Quarterly Consultation Papers.

The new LR is not a mandatory disclosure requirement and the new rules proposed by the BEIS consultation are yet to have legislative force. However, we are getting a clearer picture of the likely disclosure regime in the UK and in particular: the regulatory guidance around the compliance basis; the clear anticipated milestones this year relating to data and metrics guidance and best practice; and the forthcoming Consultation Paper by the FCA on the scope expansion (including compliance basis) of the new LR. That picture suggests the transition to mandatory climate-related disclosure requirements may well be a small step, rather than a giant leap.

Simon Clarke
Simon Clarke
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Nihar Lovell
Nihar Lovell
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Sousan Gorji
Sousan Gorji
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+44 20 7466 2750

Supreme Court hands down judgment in FCA’s Covid-19 Business Interruption Test Case

The Supreme Court has today handed down judgment in the Covid-19 Business Interruption insurance test case of The Financial Conduct Authority v Arch and Others. Herbert Smith Freehills acted for the FCA who advanced the claim for policyholders.

The Supreme Court unanimously dismissed Insurers’ appeals and allowed all four of the FCA’s appeals (in two cases on a qualified basis), bringing positive news to policyholders across the country that have suffered business interruption losses as a result of the Covid-19 pandemic.

At first instance the FCA had been successful on many of the issues, and now the Supreme Court has substantially allowed the FCA’s appeal on the issues it chose to appeal. The practical effect is that all of the insuring clauses which were in issue on the appeal will provide cover for the business interruption caused by Covid-19.

For more information, please see this post on our Insurance Notes blog.

Climate-related disclosures for issuers: FCA publishes final rules

The Financial Conduct Authority (FCA) has published a Policy Statement (PS20/17) and final rules and guidance in relation to climate-related financial disclosures for UK premium listed companies.

Companies will be required to include a statement in their annual financial report which sets out whether their disclosures are consistent with the Task Force on Climate-related Financial Disclosures (TCFD) June 2017 recommendations, and to explain if they have not done so. The rule will apply for accounting periods beginning on or after 1 January 2021.

As well as some additional guidance, the FCA has made only one material change to the rules consulted upon in March 2020 (CP20/03) with the final LR 9.8.6(8)(b)(ii)(C) R requiring non-compliant companies to set out details of how and when they plan to be able to make TCFD-aligned disclosures in the future.

With regard to monitoring compliance with the new listing rule, the FCA confirmed in its Policy Statement that it will provide further information on its supervisory approach to the new rule in a Primary Market Bulletin later in 2021.

In light of this latest regulatory development, issuers may also want to consider what, if any, litigation risks may arise in connection with climate-related disclosures (and indeed other sustainability-related disclosures which are made in response to these regulatory developments). There may be an increased risk of litigation under s90 FSMA, s90A FSMA, or in common law or equity. This was considered in greater detail in our recent Journal of International Banking & Financial Law article (published in October 2020) in which we also examined the existing climate-related disclosure requirements, the impact of the FCA’s proposals on issuers and how issuers can mitigate against such litigation risks.

Our article can be found here: Climate-related disclosures: the new frontier?

For a more detailed analysis of the FCA’s Policy Statement, please see our Corporate Notes blog post.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750

Climate-related disclosures for issuers: next steps from UK financial regulators outlined

This month, there have been some significant regulatory announcements in relation to climate-related disclosures. These announcements are a result of the increasing focus on climate change and sustainability risks across governments, regulators and industry and a continued move towards corporate compliance with the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations.

While not launching new developments or heralding the unexpected, these announcements are noteworthy for issuers as they mark a change in tone from the UK regulators regarding climate-related disclosures. Previously, the Financial Conduct Authority (FCA) and Prudential Regulation Authority took a cooperative and directional view, in recognising that issuers’ capabilities were continuingly developing in some areas which might limit their ability to model and report scenarios in the manner recommended by the TCFD. With the latest announcements, it seems increasingly likely that there will now be a shift away from voluntary climate-related disclosures towards mandatory TCFD aligned disclosures across the UK economy.

Key announcements

Recent key announcements include:

  • HM Treasury publishing the Interim Report of the UK’s Joint Government-Regulator TCFD Taskforce (the Taskforce) on the implementation of the TCFD recommendations and a roadmap towards mandatory climate-related disclosures;
  • the Governor of the Bank of England’s (BoE) speech reaffirming what the BoE is doing to ensure that the UK financial system plays its part in tackling climate change;
  • the FCA’s speech on rising to the climate challenge; and
  • the Financial Reporting Council’s (FRC) publication of its Thematic Review on climate-related risk.

Summary of key announcements

These announcements highlight the UK’s financial regulators’ strategy for improving and developing climate-related disclosures. The key points from these announcements include:

Taskforce

  • The Taskforce’s Interim Report highlighted the UK government’s commitment to introduce mandatory climate-related financial reporting, with a “significant portion” in place by 2023, and mandatory requirements across the UK economy by 2025. The Interim Report considered regulatory steps around tackling climate change, and also identified proposed legislative changes from the Department for Business, Energy and Industrial Strategy (which is intending to consult in the first half of 2021 on changes to the Companies Act 2006 to insert requirements around the TCFD recommendations on compliant disclosures in the Strategic Report of companies’ Annual Reports and Accounts, including large private companies registered in the UK).
  • The Taskforce strongly supports the International Financial Reporting Standards Foundation’s proposal to create a new global Sustainability Standards Board on the basis that internationally agreed standards will help to achieve consistent and comparable reporting on environmental and, social and governance (ESG) matters.

BoE

  • The BoE reaffirmed its commitment to driving forward the business world’s response to tackling climate change and reiterated the importance of data and disclosure in firms’ attempts to manage climate risk.
  • The BoE announced that the delayed climate risk stress test (its biennial exploratory scenario dubbed “Climate BES”) for the financial services and insurance sectors would be carried out in June 2021.
  • While the Climate BES will not be used by the BoE to size firms’ capital buffers, the BoE has put down the marker that it expects firms to be assessing the impact of climate change on their capital position over the coming year and will be reviewing firms’ approaches in years to follow.
  • The BoE also directed financial firms and their clients to the TCFD recommendations to encourage focus and drive decision-making, pointing to the benefits that the BoE has itself felt from reporting this year in line with the TCFD recommendations.

FCA

  • The FCA confirmed that from 1 January 2021 new rules will be added to the Listing Rules requiring premium-listed commercial company issuers to report in line with the TCFD recommendations. As anticipated by last year’s Feedback Statement, the new rule will be introduced on a ‘comply or explain’ basis. The general expectation is that companies will comply, with expected allowances for modelling, analytical or data based challenges. It is expected that these allowances would be limited in scope. The Taskforce’s Interim Report notes that the FCA is considering providing guidance on the “limited circumstances” where firms could explain rather than comply. A full policy statement and confirmation of the final rules are expected before the end of 2020.
  • The FCA is also intending to consult on “TCFD-aligned disclosure” by asset managers and life insurers. These disclosures would be aimed at “clients” and “end-investors”, rather than shareholders in the firm itself. The consultation is intended for the first half of 2021 and is stated that “there will be interactions with related international initiatives, including those that derive from the EU’s Sustainable Finance Action Plan” (it should be noted that such standards cover much more than climate disclosures). Current indications are that these disclosure standards would come into force in 2022.
  • The FCA is co-chairing a workstream on disclosures under IOSCO’s Sustainable Finance Task Force, with the aim of developing more detailed climate and sustainability reporting standards and promoting consistency across industry.

FRC

  • The FRC emphasised that all entities (boards, companies, auditors, professional advisers, investors and regulators) needed to “do more” to integrate the impact of climate change into their decision making. One of the FRC’s ongoing workstreams is investigating developing investor expectations and better practice reporting under the TCFD recommendations.

Regulatory reporting requirements and litigation risks for issuers

The recent announcements are a reminder by the UK’s financial regulators that issuers must look beyond the current Covid-19 crisis to the oncoming climate emergency. It is clear that not engaging is not an option, even as the regulatory environment continues to change. Issuers and firms will therefore want to consider the impact of those disclosure requirements/suggestions across the board, from investor interactions to regulatory reporting to meeting supervisory expectations.

As the sands shift, issuers may also want to consider what, if any, litigation risk may arise in connection with climate-related disclosures (and indeed other sustainability related disclosures that are brought out from the shadows with these regulatory developments). There may be an increased risk of litigation under s90 FSMA, s90A FSMA, or in common law or equity. This was considered in greater detail in our recent Journal of International Banking & Financial Law article (published in October 2020) where we also examined the existing climate-related disclosure requirements, the impact of the FCA’s proposals on issuers and how issuers can mitigate against such litigation risks.

Our article can be found here: Climate-related disclosures: the new frontier?

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Nish Dissanayake
Nish Dissanayake
Partner
+44 20 7466 2365
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7374 8000
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750

Climate-related disclosures: the new frontier?

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law on the Financial Conduct Authority (FCA)’s proposals for regulating climate-related disclosures and the litigation risks which may arise for issuers from such proposals.

Climate change has been part of the political and regulatory discourse for years. However, it is an issue which is gaining increasing prominence on the global stage. Over a thousand companies now support the Task Force on Climate-related Financial Disclosures (TCFD)’s recommendations, while shareholder activism in the climate arena is stretching beyond Greenpeace’s proposed resolutions at energy companies’ AGMs. Against this backdrop, both the EU and the UK have advocated for adapting their financial systems to address climate risks. Whilst the European Central Bank and Bank of England are addressing the risks from climate change in their financial systems, attention has also turned to how companies themselves can be affected by climate change, both in terms of risk assessment and management, and in terms of investor and market-facing disclosures. The current legal framework regarding issuer disclosure already provides some requirements for issuers to disclose climate-related risks in certain circumstances. However, the existing disclosure requirements fall short when it comes to consistent and meaningful disclosures. There are therefore systemic and policy drivers to increase transparency, reporting and potential regulation in this space.

The FCA has noted that voluntary adoption of the TCFD’s recommendations has been increasing. However, based on the feedback that the FCA received in response to a 2018 Discussion Paper, the FCA considers that there is evidence to support the case for it to intervene to accelerate such progress.

In our article, we examine the existing disclosure requirements for issuers, the FCA’s new proposals for regulating climate-related disclosures, the FCA’s reasons behind the proposals, how issuers will be impacted by the proposed regulatory change, the litigation risks which may arise for issuers and how issuers can mitigate against such litigation risks.

This article can be found here: Climate-related disclosures: the new frontier? This article first appeared in the October 2020 edition of JIBFL.

Simon Clarke
Simon Clarke
Partner
+44 20 7466 2508
Nihar Lovell
Nihar Lovell
Senior Associate
+44 20 7374 8000
Sousan Gorji
Sousan Gorji
Senior Associate
+44 20 7466 2750

Judgment handed down in FCA’s COVID-19 business interruption insurance test case

The High Court has today handed down judgment in the COVID-19 Business Interruption insurance test case of The Financial Conduct Authority v Arch and Others. Herbert Smith Freehills represented the FCA (who was advancing the claim for policyholders) in the case, which considered 21 lead sample wordings from eight insurers. Following expedited proceedings, the judgment brings highly-anticipated guidance on the proper operation of cover under certain non-damage business interruption insurance extensions.

While different conclusions were reached in respect of each wording, the court found in favour of the FCA on the majority of the key issues, in particular in respect of coverage triggers under most disease and ‘hybrid’ clauses, certain denial of access/public authority clauses, as well as causation and ‘trends’ clauses. The judgment should therefore bring welcome news for a significant number of the thousands of policyholders impacted by COVID-related business interruption losses.

For more information see this post on our Insurance Notes blog.

Privilege in the context of regulatory investigations: latest guidance from the High Court

Another recent High Court decision has considered the question of privilege in a regulatory context: A v B & Anor [2020] EWHC 1491 (Ch).

As with other recent decisions of this kind, the issue arose in the context of an auditor required to produce documents to its regulator, the Financial Reporting Council (“FRC”). The decision is likely to be of broader interest to financial services institutions, because it may indicate the approach the court is willing to take more generally in cases involving a regulator using its powers of document compulsion, such as the FCA.

In the present case, the FRC sought disclosure from the auditor of documents belonging to the auditor’s client, and over which the client claimed privilege. However, there was a dispute between the auditor and its client as to whether the documents were – in fact – privileged. Importantly, the court held that the auditor must form its own view on whether documents are privileged and can therefore be withheld on that ground, regardless of whether the privilege is that of the auditor or its underlying client. It considered that the duty to disclose was on the auditor and disclosure could only be refused on the grounds that a document was actually privileged. Mere assertion of privilege by the client was insufficient.

In the context of the FCA’s powers to compel a regulated person to disclose documents, the question would be whether the client’s documents are “protected items” under s.413 of the Financial Services and Markets Act 2000. Following the decision in Sports Direct International plc v The Financial Reporting Council [2020] EWCA Civ 177 (see our post here), there could be no argument that disclosure of the documents (if indeed subject to privilege) would not amount to infringement of the client’s privilege, or that the client’s privilege has been lost by providing those documents (on a limited waiver basis) to the regulated person.

However, the same question may arise as to which party is required to determine whether privilege attaches to the documents in question. Subject to any appeal, the decision suggests that the regulated person cannot refuse to produce documents on the grounds that a claim to privilege has been asserted or could be asserted by a client (or other third party to whom duties of confidentiality are owed); the regulated person must take its own view on the privilege claim.

For a more detailed analysis of the decision, please read our litigation blog post.

The transition from LIBOR: FCA conduct risk warning and next steps

Over the past couple of weeks, the FCA has released two important communications in the context of the discontinuation of LIBOR, which is expected to cease after end-2021.

On 19 November 2019, the FCA published a paper setting out a series of questions and answers for firms about conduct risk during LIBOR transition. Then on 21 November 2019, a speech was made by Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, setting out the next steps in transition from LIBOR from the FCA’s perspective. We consider below what these communications tell the market about the current approach being adopted by the FCA to LIBOR transition, together with the key takeaways in relation to regulatory risks and next steps.

Conduct risks Q&A publication

For context, the background to the conduct risks Q&A communication from the FCA is:

  • The Dear CEO letters published by the FCA in September 2018, which asked for details of the preparations and actions being taken by major banks and insurers in the UK to manage transition from LIBOR to alternative interest rate benchmarks (SONIA in the UK).
  • A joint statement published by the FCA and PRA setting out their key observations from the responses of those firms to the Dear CEO letters, in particular identifying a number of critical elements which were present in “stronger responses”.

We considered the thematic feedback and guidance provided by the joint statement in a previous banking litigation blog post. One of the key themes of the joint statement was the real divergence across the market in terms of preparedness for LIBOR discontinuation.

While the joint statement previously identified and emphasised good practice for LIBOR transition, the FCA appears to have changed tactics and approach to engage market participants in its latest missive. The conduct risks Q&A communication is framed as the publication of initial answers to some of the most commonly raised conduct questions, but it is clearly designed to highlight the regulatory risks of failing to prepare properly for LIBOR transition, and is likely aimed primarily at those at the weaker end of the spectrum in terms of the responses to the Dear CEO letters (although of course applicable to all).

The conduct risk Q&As offer only general guidance to firms, but we highlight below some of the key takeaways emphasised by the FCA.

Governance and accountability

  1. DO identify the Senior Manager responsible for overseeing transition away from LIBOR (for firms subject to the Senior Managers and Certification regime) and detail those responsibilities in the relevant Senior Manager’s Statements of Responsibilities.
  2. DO consider whether any LIBOR-related risks are best addressed within existing conduct risk frameworks or need a separate, dedicated program.
  3. DO keep appropriate records of management meetings or committees that demonstrate the firm has acted with due skill, care and diligence in their overall approach to LIBOR transition and when making decisions impacting customers.
  4. DO consider and address potential impact and risk in an appropriately coordinated way across a firm: how it will impact overall business strategy and front-office client engagement, rather than being a narrow legal and compliance risk.

Replacing LIBOR with alternative rates in existing contracts/products

  1. DON’T use LIBOR discontinuation to move customers with continuing contracts to replacement rates that are expected to be higher than what LIBOR would have been, or otherwise introduce inferior terms.
  2. DO communicate effectively with customers as to how fall-back provisions are expected to operate (e.g. whether clauses operate at, or before cessation, and on what basis) where fall-back provisions are inserted in existing contracts to replace LIBOR with a new reference rate.
  3. DO consider whether any contract term relied on by the firm to amend a LIBOR-related product is fair under the Consumer Rights Act 2015 in respect of consumer contracts.

Offering new products with risk free rates (“RFRs”) or alternative rates

  1. DO offer new products that reference RFRs and other alternative rates that meet customers’ needs, rather than LIBOR-linked products.
  2. If offering LIBOR-linked products which mature after end-2021, DO take care in describing to the customer the risks associated with LIBOR ending and how it will affect them; and be aware that there is a risk that some customers may not fully understand the implications.

Communicating with customers about LIBOR and alternative rates/products

  1. DO ensure that existing customers with legacy contracts are appropriately informed about what will happen in the event of LIBOR ending and its effect on the customer (the Q&A publication includes a number of points of more detailed guidance to ensure customers are appropriately informed, e.g. ensuring relevant client-facing staff have adequate knowledge and competence to understand the implications of LIBOR ending and can respond to client queries appropriate, which may require additional training).
  2. DON’T delay conversations with customers to the point the client is left with insufficient time to understand their options and make informed decisions.

Next steps in LIBOR discontinuation

The speech delivered by Edwin Schooling Latter on 21 November 2019 is the latest in a line of speeches on LIBOR discontinuation from senior directors at the FCA. We highlight below the most important points of interest in this speech, from the perspective of banks and other financial institutions.

Possibility of a legislative fix

While it is fair to say that there has been no softening in the FCA’s message that LIBOR will cease at end-2021, there has been some degree of variance between the various speeches on what assistance (if any) the market can expect in particular in relation to some form of legislative fix.

In a speech by Andrew Bailey, Chief Executive of the FCA, on 15 July 2019, the FCA hinted at the possibility – for “tough” legacy contracts – of legislators redefining LIBOR as RFRs plus fixed spreads. Mr Bailey was clear that this option should not be relied upon to be deliverable, but suggested that there would be a consultation on the possibility of legislation in the second half of 2019. In what will no doubt be a disappointment to many market participants, there was no update or further elaboration of this suggestion in the latest speech by Mr Schooling Latter. While such an option in the UK was not explored, the FCA noted that a legislative fix is being considered in the United States in relation to bond conversations – building in a so-called pre-cessation trigger.

Pre-cessation trigger in the derivatives market

The FCA’s wider discussion of the inclusion of a pre-cessation trigger is noteworthy, in particular its comments and concerns in relation to contractual fall-backs in the global derivatives market (because of the systemic importance of LIBOR in the swaps market). By way of brief background, the International Swaps and Derivatives Association (“ISDA”) has consulted derivatives market participants on a number of aspects of the proposed fall-back provisions in ISDA documentation, including whether or not to include a pre-cessation trigger (see the consultation and the results).

The ISDA pre-cessation trigger consultation was engaged because of concerns from the FCA and the Financial Stability Board Official Sector Steering Group (“OSSG”) that the “end-game” for LIBOR may include a period in which it is still published (post end-2021, when panel banks are no longer compelled to submit rates), but no longer passes the key regulatory test in the European Benchmarks Regulation of being capable of measuring the underlying market or economic reality, i.e. it is not “representative”. In such circumstances, the FCA could make a public statement that LIBOR is no longer representative (likewise, other regulators could make a statement that the relevant covered IBOR is no longer representative). The purpose of the ISDA consultation was to determine whether and how to include a pre-cessation trigger regarding “representativeness”, so that the relevant fall-backs would be triggered following such an announcement. The majority of respondents supported the inclusion of a pre-cessation trigger, but there was some variation of views on how best to implement that trigger, with support for an optional approach (i.e. where market participants could choose whether or not to include the pre-cessation trigger, with the result that some amended legacy derivatives contracts would include such a trigger and some would not).

It is very clear from the recent speech that the FCA is in favour of the pre-cessation trigger in ISDA documentation being integral and not optional, saying that reservations expressed by respondents to the consultation about making the trigger optional were “compelling”. Considering the other side of this debate, the FCA addressed (in some detail) the principal concerns from respondents who expressed reservations about including both triggers as standard (i.e. removing optionality and making the pre-cessation trigger integral). The FCA’s view is in line with that of the OSSG, which wrote to ISDA to encourage them to consult on making the pre-cessation trigger an integral, and not optional, part of the standard language.

Given the view of the regulators, it seems likely that the next word from ISDA on contractual fall-backs will be to consult market participants to make a final decision on whether the pre-cessation trigger should be integral or optional.

Loan market

The FCA remains concerned by the volumes of new LIBOR-linked loans being written which mature after end-2021. While the FCA accepts the challenges inherent in transition for the loan market, it emphasised the following key messages for market participants:

  • The target to stop new lending using LIBOR is Q3 2020 (as set by the sterling RFR Working Group).
  • The loan market should not delay transition of new business away from LIBOR until the production of forward-looking term rates based on SONIA; the market is capable of shifting to overnight rates compounded in arrears (in the same way as the bond and securitisation markets).
  • The FCA accepted that there may be some parts of the loan market where forward-looking term rates are needed (e.g. to calculate fair replacement rates for legacy LIBOR contracts that cannot be amended to work on overnight rates compounded in arrears). Forward-looking SONIA term rates will therefore be the central issue in a forthcoming sterling RFR Working Group publication on term rate use cases.

Rupert Lewis
Rupert Lewis
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Harry Edwards
Harry Edwards
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Nick May
Nick May
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Ceri Morgan
Ceri Morgan
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Jon Ford
Jon Ford
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The Financial Services Duty of Care Bill

On 29 October Lord Sharkey introduced a Private Members’ Bill into the House of Lords, which proposed amending the Financial Services and Markets Act 2000 (“FSMA”) to empower the FCA to introduce a duty of care owed by authorised persons to consumers in carrying out regulated activities under FSMA (the “Bill”).

The Bill proposed that a duty of care be defined as an obligation to exercise reasonable care and skill when providing a product or a service.  Whether or not this statutory duty would provide a private cause of action for customers to pursue claims against financial institutions would depend on how the duty was introduced by the FCA (if the proposed amendments to FSMA were made). This is because the FCA determines which rules, if breached, are actionable by a “private person” under section 138D FSMA.  For example, there is currently no right of action for breach of the FCA’s Principles for Business, whereas breach of certain rules in the Conduct of Business Sourcebook may be actionable under section 138D FSMA. Accordingly, the effect of the proposed Bill on any future civil liability risks for financial institutions would be dependent on the position adopted by the FCA. In this regard, it is noteworthy that most respondents to the FCA’s previous Discussion Paper (18/5) did not support a new statutory duty of care (see blog post for further details).

Our Financial Services and Regulatory colleagues have considered and commented on the proposed Bill in their recent FSR blog post.

Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
John Corrie
John Corrie
Partner
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Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948

 

 

LIBOR discontinuation – FCA thematic feedback on responses to Dear CEO letter

The FCA and PRA yesterday published a joint statement setting out their key observations from the responses of major banks and insurers in the UK to the Dear CEO letters published in September 2018, which asked for details of the preparations and actions being taken by those firms to manage transition from LIBOR to alternative interest rate benchmarks (SONIA in the UK).

The statement confirms that the FCA and PRA have reviewed responses from those firms and provided feedback directly. In addition, given the market-wide nature of the issue, they have decided to publish a number of market-wide observations which they have made in the course of reviewing the responses to the Dear CEO letters. The FCA and PRA identify a number of critical elements which were present in “stronger responses” to the Dear CEO letters, which are summarised below and provide some helpful guidance for other firms affected by LIBOR discontinuation.

As repeatedly emphasised by the FCA and PRA, given the widespread use of and reliance on LIBOR, there are significant risks associated with transitioning from LIBOR to alternative risk free rates. We considered in some detail the potential litigation risks in our article published in the Journal of International Banking Law and Regulation: LIBOR is being overtaken: Will it be a car crash? (2019) 34 J.I.B.L.R..

The stated purpose of the Dear CEO letter was to seek assurance that firms’ senior managers and relevant governance committee(s) understand the risks and are taking appropriate action now. It is clear from the joint statement that there is real divergence across the market in terms of preparedness for LIBOR discontinuation. This latest communication is a further call to action from the FCA and PRA to ensure firms are properly prepared for the transition.

Good practice identified by the FCA and PRA for LIBOR transition

  1. Identifying reliance on and use of LIBOR beyond a firm’s balance sheet exposure and assessing (for example) whether LIBOR is present in the pricing, valuation, risk management and booking infrastructure firms use.
  2. Quantification of LIBOR exposures using a range of quantitative and qualitative tools and metrics, keeping the metrics up to date.
  3. Nominating a senior executive covered by the Senior Manager Regime as the responsible executive for transition, with clarity on the senior manager’s role in transition work.
  4. Developing a project plan for transition with sufficient granularity of detail, including key milestones and deadlines to ensure delivery by end-2021.
  5. Carrying out a detailed prudential risk assessment (subject to appropriate review and challenge), taking a broad view and considering all risks that could be relevant to a firm’s operations. Aligning identified risks with appropriate mitigating actions.
  6. Identifying a range of conduct risks, including management of potential asymmetries of information and the potential for conflicts of interest, when forming and reviewing transition plans. Again, aligning identified risks with appropriate mitigating actions.
  7. Planning and managing risks on the basis of LIBOR discontinuation at the end of 2021, rather than assuming that it will continue in some form thereafter.
  8. Demonstrating a good understanding of and involvement in with relevant industry initiatives.
  9. Proactively transacting using new risk free rates or taking steps to incorporate robust fallback language.

In a speech given on the same date this feedback was published, Dave Ramsden (Deputy Governor for Markets and Banking at the Bank of England) made clear that regulatory scrutiny in relation to LIBOR transition will continue:

More generally, I only see the level of supervisory engagement on this topic intensifying to make sure firms are ready for end 2021. The response to the Dear CEO letter provides a basis for this engagement to continue.”

Firms (whether recipient of the original Dear CEO letter or not) should therefore reflect carefully on the published feedback. No doubt it will also be of interest to firms considering benchmark transition issues in other jurisdictions, notably in Hong Kong and Australia where the regulators have similarly asked firms to confirm their preparedness.

Jenny Stainsby
Jenny Stainsby
Partner
+44 20 7466 2995
Harry Edwards
Harry Edwards
Partner
+44 20 7466 2221
Ceri Morgan
Ceri Morgan
Professional Support Lawyer
+44 20 7466 2948
Alexandra Payne
Alexandra Payne
Associate (Australia)
+44 20 7466 2743