ESG for financial institutions – Top five trends in UK and EU regulation for 2023

As financial institutions get to grips with the opportunities and challenges presented by the constantly evolving ESG landscape, our FSR colleagues have outlined the top five trends that they are seeing in this space. From a disputes perspective, particularly for mis-selling and securities class action claims, it is important that firms take note of these trends as they are likely to influence the ESG agenda into 2023 and beyond.

The top 5 trends are as follows:

  • Impact of the energy crisis on the ESG agenda
  • Increasing focus on the ‘S’ and ‘G’ in ESG
  • Divergence and convergence in international approaches
  • The ESG data challenge
  • Greenwashing and ESG enforcement

For more information on each of the trends, please see our FSR Notes blog post.

Russian sovereign debt defaults: a disputes perspective

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law (JIBFL) on Russia’s default on its foreign currency sovereign debts from the perspective of potential disputes and litigation.

Russia’s default on its foreign currency sovereign bonds is unprecedented and likely to lead to bondholder litigation as well as derivatives disputes. The article highlights the reasons for Russia’s default and explores the scope of potential bondholder litigation, together with some of the obstacles which bondholders may face in bringing claims against Russia. The article then considers the ripple effect on the derivatives market, where it is possible that investors in products linked to Russian debt may seek to recover losses by bringing mis-selling claims.

The article can be found here: Russian sovereign debt defaults: a disputes perspective and first appeared in the September 2022 edition of JIBFL.

Daniel May
Daniel May
Senior Associate
+44 20 7466 7608
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nick May
Nick May
Partner
+44 20 7466 2617
Susannah Cogman
Susannah Cogman
Partner
+44 20 7466 2580
Minolee Shah
Minolee Shah
Professional Support Consultant
+44 20 7466 207

Navigating UK sanctions against Russian persons in English court proceedings

The UK is one of many countries which have introduced extensive sanctions against Russia, its individuals and entities in light of the military action in Ukraine which began on 24 February 2022. The application of the sanctions is generally limited to the territory of the UK and the conduct of UK persons (as defined) inside or outside the UK, but their practical effect is nevertheless wide-ranging.

An area where the UK sanctions regime may have significant impact, but which is not often discussed, is the effect on proceedings in the English court involving sanctioned Russian parties. Whilst UK sanctions generally do not restrict court proceedings against Russian individuals or entities subject to sanctions, the effect of the overall sanctions regime means that pursuing such claims may involve practical difficulties, such as delays to the proceedings or issues with enforcement. Those who wish to pursue claims against sanctioned Russian persons in the English courts therefore need to understand how to navigate the relevant sanctions in order not to be caught off-guard by such difficulties.

For a background to the sanctions regime and potential difficulties arising from asset freeze restrictions, please see our Litigation Notes blog post.

Data Objects: Law Commission of England & Wales proposes new category of personal property

On 28 July 2022, the Law Commission of England and Wales published a consultation paper on the recognition and protection of digital assets. The consultation paper recommends law reform to recognise a third category of personal property – referred to as “data objects” – in addition to things in possession (such as physical objects) and things in action (such as contractual rights).

The consultation paper acknowledges the flexibility of English law to accommodate digital assets within existing legal principles (including crypto-tokens and cryptoassets). However, the Law Commission recommends reform to ensure “data objects” are treated consistently under English law and, thus, to promote greater legal certainty.

For more information see this post on our FSR and Corporate Crime blog.

FCA confirms final rules for new Consumer Duty

The FCA has published the final rules and guidance and accompanying non-Handbook guidance relating to the new Consumer Duty (the Duty).

While the nature and scope of the Duty remains largely unchanged in most areas, the final rules and guidance contain some significant changes and clarifications relating to how the Duty will apply in relation to distribution chains, closed books, wholesale markets and funds and asset managers and where firms provide products or services to occupational pension schemes. Helpfully, firms have been given more time to implement the changes needed to comply with the Duty.

From a disputes perspective, the FCA kept its powder dry on the possibility of a private right of action for breaches of any part of the Duty, saying that the possibility was being kept under review following the initial consultation. Financial services firms will welcome confirmation that no private right of action has been incorporated in the final rules. Firms will still be accountable for any breach of the Duty through the Financial Ombudsman Service framework (which is now subject to increased award limits).

For a more detailed analysis of the final rules and timeframe for compliance, please see our FSR Notes blog post.

Global LIBOR Legislative Solutions

Herbert Smith Freehills LLP have published an article in Bloomberg Law detailing the key legislative and/or regulatory solutions that jurisdictions have adopted to mitigate the risks raised by so-called “tough legacy” contracts following the discontinuation of the London Inter-Bank Offered Rate (LIBOR) on 31 December 2021 in nearly all currencies and tenors (with an extension for certain tenors of USD LIBOR until 30 June 2023).

Tough legacy LIBOR contracts are financial instruments that incorporated LIBOR as a term for the payment of interest but lacked a workable (or in some cases, any) “fallback” rate to replace LIBOR.

In our article, we summarise the solutions adopted by legislators and regulators to mitigate the risks of such contracts, all aimed at ensuring contractual continuity and reducing litigation risks. We also identify some coverage gaps and suggest that some of the approaches are potentially inconsistent.

The article can be found here: Global LIBOR Legislative Solutions. The article first appeared in Bloomberg Law in April 2022.

Jenny Stainsby
Jenny Stainsby
Partner, London
+44 20 7466 2995
Lisa Fried
Lisa Fried
Partner, New York
+1 917 542 7865
Marc Gottridge
Marc Gottridge
Partner, New York
+1 917 542 7807
Rupert Lewis
Rupert Lewis
Partner, London
+44 20 7466 2517
Ceri Morgan
Ceri Morgan
Professional Support Consultant, London
+44 20 7466 2948

The Financial Services and Markets Bill – a new vision for future UK financial services

In a speech delivered at Mansion House on 19 July 2022, the Chancellor of the Exchequer, The Rt Hon Nadhim Zahawi MP, sets out the government’s vision for the future of UK financial service and discusses proposals which aim to keep the UK “the most open, inclusive, welcoming, competitive, safe, and transparent place to do financial services business, in the world”. The government’s vision for a “more open, competitive, green, and technologically enabled” financial sector is being delivered in the form of the Financial Services and Markets Bill (Bill) which was introduced in Parliament today. Second reading of the Bill is expected to take place in the autumn, after Parliament returns from summer recess.

For an overview of some of the areas covered by the Bill, please read this blog post produced by our Financial Services Regulatory team.

Reform of the UK prospectus regime – update on securities litigation risk

HM Treasury (HMT) has published a response setting out its policy approach to reforming the UK’s prospectus regime, in the biggest shake up since 2005. The response follows the initial consultation published in July 2021.

HMT’s intention is to proceed with the reforms broadly as proposed in its initial consultation. The next step is for HMT to make the necessary legislative changes to the Financial Services and Markets Act 2000 (FSMA), to create the framework for the new regime when parliamentary time allows.

The idea behind these changes is to simplify regulation in this area, as well as facilitating wider participation in the ownership of public companies and improving the quality of information investors receive. As part of this, HMT will delegate a greater degree of responsibility to the Financial Conduct Authority (FCA) to set out the detail of the new regime through rules. The full suite of reforms will take effect after the FCA has consulted on, and is ready to implement, new rules under its expanded responsibilities. HMT is keen to return responsibility for designing and implementing financial services regulatory requirements to regulators. For more information on the reforms themselves, please see this detailed briefing produced by our Capital Markets team.

From a securities litigation perspective, in light of the ever-evolving statutory and regulatory landscape, it is important issuers continue to monitor the impact of any changes to their disclosure requirements. HMT’s reforms of the UK’s prospectus regime are likely to have a potential impact on claims under s.90 FSMA for liability for prospectuses and listing particulars. For more information on this impact, please see our previous blog post: HMT reform of prospectus regime: the potential impact on securities litigation.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7466 2529

Regulation in Focus Podcast – Operational Resilience

Our FSR colleagues’ latest Regulation in Focus podcast features two former regulators in conversation about operational resilience – Andrew Procter from Herbert Smith Freehills and Michael Sicsic from Sicsic Advisory.

The discussion focuses on the implementation of operational resilience requirements for the upcoming UK regulatory deadline of 31 March 2022, including a discussion of the regulatory and litigation risks for financial institutions.

To listen to the podcast and for more details, please see our FSR Notes blog post.

Final part of UK LIBOR legislative solution receives Royal Assent

This week, the Critical Benchmarks (References and Administrators’ Liability) Act 2021 received Royal Assent and will now pass into UK law.

The Critical Benchmarks Act represents the final part of the UK’s legislative framework to deal with LIBOR cessation and its passage is welcome news, particularly with the hard deadline for most currencies of LIBOR (save for certain USD tenors) fast approaching at the end of this year.

In this blog post, we explain the overarching mechanism of the UK legislative regime, some key takeaways from the Critical Benchmarks Act, and the likely impact on litigation risk.

UK legislative mechanism: a two-stage process

The UK legislative solution has been enacted via two separate pieces of legislation, both of which make amendments to the retained EU law version of the Benchmarks Regulation (EU) 2016/1011 (UK BMR):

  1. Firstly, amendments have been introduced by the Financial Services Act 2021 (FSA 2021) to grant the FCA new and enhanced powers to manage the wind-down of a critical benchmark (i.e. LIBOR, which is the benchmark we will focus upon in this blog post).
  2. Secondly, amendments have been introduced by the Critical Benchmarks Act 2021 to clarify the way in which a reference to LIBOR should be interpreted in individual contracts after the exercise of the FCA’s powers granted under the FSA 2021.

We consider each element of the legislative solution in turn below.

The Financial Services Act 2021

The FSA 2021 gives the FCA new and enhanced powers to manage the wind-down of LIBOR, as discussed in our previous blog post LIBOR transition measures in the new Financial Services Bill: the legal framework, market impact and risks.

The outcome of the FCA using its new regulatory powers will be the publication, from 4 January 2022, of so-called “synthetic” LIBOR for 1-month, 3-month and 6-month sterling LIBOR and all yen LIBOR tenors, by ICE Benchmark Administration.

The effect of publication of synthetic LIBOR on individual contracts is not expressly catered for within the FSA 2021, which deals only with the powers granted to the regulator. For this reason the Critical Benchmarks Act has been introduced, to address any legal uncertainty by clarifying the way in which a reference to LIBOR should be interpreted in a contract or other arrangement after the exercise of the FCA’s powers.

The Critical Benchmarks Act 2021

The key features of the Critical Benchmarks Act, which are likely to be of interest to financial institutions, are as follows:

Express contractual continuity

The express contractual continuity provisions in the Critical Benchmarks Act have the following key pillars:

  • LIBOR = synthetic LIBOR. Article 23FA paragraph 1 confirms that references to LIBOR in a contract or arrangement should be treated as references to synthetic LIBOR, once it has been designated as an Article 23A benchmark by the FCA and the new synthetic LIBOR methodology has kicked in. Accordingly, from 4 January 2022, synthetic LIBOR will be “deemed” into each contract or arrangement that references one of the six exempt LIBOR settings. This applies regardless of how references to LIBOR are expressed, including where LIBOR is described, rather than being named expressly (paragraph 2).
  • Synthetic LIBOR deemed from inception. Article 23FA paragraph 5 seeks to prevent parties from arguing that the introduction of synthetic LIBOR into the contract on 4 January 2022 constitutes a change in the contract. It does this by stating that once synthetic LIBOR is deemed to be the reference rate in the contract, the contract will be treated for all purposes as if it always referenced synthetic LIBOR.
  • Retrospective application. Article 23FA paragraph 4 ensures that the deeming of synthetic LIBOR into a contract or arrangement will apply regardless of when the contract was formed, i.e. the Critical Benchmarks Act will have retrospective application, and apply to contracts formed before it came into full force and effect.

Protection from claims

Paragraph 5 of Article 23FA may address arguments that the change to synthetic LIBOR amounts to a frustration/force majeure event or breach of contract. As noted above, once synthetic LIBOR is deemed into the contract, the contract is to be treated for all purposes as having always referenced the synthetic rate.

Further protection from claims is provided by paragraph 6(a) and 6(b) of Article 23FA:

  • Paragraph 6(a) provides that nothing in “this Article” (i.e. Article 23FA) creates any liability in relation to an act or omission relevant to the formation or variation of a contract which took place before the introduction of synthetic LIBOR. Paragraph 61 of the Explanatory Notes to the legislation confirms that any claims based on alleged misrepresentations made before the introduction of synthetic LIBOR are to be considered according to the actual reality at the relevant time the representations were made.
  • Paragraph 6(b) provides that nothing in “this Article” creates any liability in relation to the operation of the contract prior to the introduction of synthetic LIBOR.

It remains to be seen how these paragraphs will be interpreted, but we expect firms to seek to rely upon paragraph 6 as part of their armoury of defences to any LIBOR transition claims.

Impact on non-financial contracts and non-BMR supervised entities

The Critical Benchmarks Act is not limited to contracts/parties in scope of UK BMR. Accordingly, the contractual continuity provisions outlined above apply equally to non-financial contracts and where neither of the counterparties are “supervised entities” for the purposes of UK BMR. See in particular paragraphs 1, 2 and 9 of Article 23FA, which confirm that references to LIBOR should be treated as references to synthetic LIBOR in: (a) any “contract or other arrangement”; and (b) even where LIBOR is not “used” as a benchmark within the scope of the UK BMR. This is also confirmed by paragraphs 42-43 and 65 of the Explanatory Notes.

Interaction with transitioned contract provisions

The Critical Benchmarks Act seeks to avoid inadvertently overriding the fall-backs or replacement rates which have been agreed between contractual counterparties through active transition (Article 23FB paragraphs 2-5). This accords with the regulatory emphasis that firms should continue to prioritise active transition away from LIBOR to alternative benchmarks, and that the legislative fix is not intended to divert attention from active transition efforts. It is also possible for parties to contract out of the safe harbour provisions (Article 23FB paragraph 1).

Impact on litigation risk

As explained in our previous blog posts on this topic, the UK’s legislative solution is a blunt tool, which will change automatically the interest rate payable under the contract when the relevant trigger is activated and LIBOR switches to synthetic LIBOR. For those parties who lose out financially, there may be a real economic incentive to bring claims, and this may provide fertile ground for litigation.

The contractual continuity provisions in the Critical Benchmarks Act should help to deter arguments based on refusal to perform contractual obligations, alleged frustration or force majeure.

Other potential claims may include mis-selling type claims (whether in contract, tort or under statute) on the basis of allegedly negligent statements and/or advice in relation to the LIBOR-referencing product at the original point of sale, where parties feel they have lost out financially as a result of conversion to synthetic LIBOR vs the original rate. Mis-selling claims may also arise in relation to products that contractual counterparties have actively transitioned away from LIBOR, on the basis that a customer is put in a position that turns out to be worse than if the same customer had not been actively transitioned, and the contract had been amended by the legislative solution.

Such claims are likely to be highly speculative, but regardless of their merits, there is a risk of disruption for firms because of the time and cost of defending them on a large scale. The UK’s final form of safe harbour does not give the clarity of the protections offered by the federal and New York legislative solutions for contracts that are switched to the “recommended benchmark replacement”, which is intended to provide comfort to market participants in adopting that benchmark proactively and reduce the risk of speculative litigation following the transition event (see our blog post: New York legislative solution for LIBOR passed: Impact on transition of legacy LIBOR contracts). However, the protections included in the Critical Benchmarks Act are welcome additions and clearly the intention of the legislators was to avoid market disruption.

The safety net afforded to non-financial contracts, enabling parties to such contracts to rely upon the contractual continuity provisions in the Critical Benchmarks Act and therefore access synthetic LIBOR, is likely to be welcomed broadly by supervised and unsupervised entities alike.

Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948
Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Jenny Stainsby
Jenny Stainsby
Partner
+44 20 7466 2995