Out-Law News 5 min. read
28 Sep 2012, 11:10 am
This would make it easier for watchdogs to supervise the rate and take enforcement action when things go wrong, according to the independent report.
Setting out the conclusions of his Government-commissioned review (92-page / 1MB PDF) of the London Interbank Offered Rate (LIBOR), Martin Wheatley also called for "administration" of the rate to be subject to regulation under the Financial Services and Markets Act (FSMA). Doing so would enable the regulator to "take regulatory action for misconduct", including financial penalties and banning firms from carrying out other regulatory activities, he said.
"At present neither submitting to LIBOR, nor administering LIBOR, is a regulated activity under FSMA," the report said. "As a result, while the [Financial Services Authority] is currently taking regulatory action in relation to attempted manipulation of LIBOR by firms, this action is processing on the basis of the connection between LIBOR submitting and other regulated activities ... This affects the FSA's ability to supervise and take enforcement action in relation to these activities, even when carried out by a firm that is regulated in respect of its general business activities."
Banking law expert Tony Anderson of Pinsent Masons, the law firm behind Out-Law.com, said that the report reflected the "trend towards replacing self-regulation of financial infrastructure with more formal arrangements" following the 2008 financial crisis. The report also recommends creating a new criminal offence under the FSMA of "the making of a false or misleading statement in order to manipulate LIBOR", allowing the FSA to investigate allegations and prosecute where required.
The report, prompted by the announcement at the end of June by Barclays Bank that it had settled with regulators in the UK and US for "misconduct" in its contributions to the rate, sets out a "comprehensive and far-reaching" 10-point plan for reform. Wheatley is managing director of the Financial Services Authority (FSA) and become chief executive of its replacement organisation the Financial Conduct Authority (FCA).
Wheatley called for "detailed technical changes" to refine the way the rate is put together - including a requirement for banks to back up their submissions with evidence of actual transactions. Responsibility for sponsoring the rate should also be taken away from banking body the British Bankers' Association (BBA), he said.
The Government will now consider the recommendations contained in the report and set out its plans when Parliament returns. Chancellor of the Exchequer George Osborne has already committed to making any necessary legislative changes as part of the Financial Services Bill, which is currently before Parliament, meaning that changes to the regulatory regime could be in force by next year.
LIBOR is a daily reference rate based on the interest rates at which banks can borrow unsecured funds from other banks. It is widely used internationally as the pricing basis for financial instruments including interest rates and currency hedging instruments, and to set the interest rate for syndicated loans. Contributing banks submit their rates directly to business date provider Thomson Reuters, which carries out the calculation and publishes LIBOR rates in 10 currencies at midday every London business day.
On 27 June Barclays announced that it was to pay total penalties worth £290 million to the FSA, US Commodity Futures Trading Commission (CFTC) and the Fraud Section of the US Department of Justice (DOJ). It said that it had also been granted conditional leniency from the DOJ's Antitrust Division "in connection with potential US antitrust law violations".
In the UK, the Serious Fraud Office (SFO) has confirmed that it is investigating "a number of financial institutions" in relation to the alleged manipulation of the rate under existing fraud and false accounting laws.
Wheatley said that his review has made it clear that the current system was "broken" but "not beyond repair".
"Trust in a vital part of the financial system has been badly damaged," he said. "Today's report sets out my plans for reforming what has become a broken system and to help restore the trust that has been lost. LIBOR needs to get back to doing what it was supposed to do, rather than what unscrupulous traders and individuals in banks wanted it to do."
As part of his plan for "rehabilitation" of the process the BBA should transfer responsibility for the rate to a new administrator chosen as a result of a tender process run by an independent committee convened by the regulatory authorities, he said. This new administrator would, he said, be responsible for "compiling and distributing" LIBOR, as well as "providing credible internal governance and oversight". To restore "credibility", the new administrator would also undergo "surveillance and scrutiny of submissions, publications of a statistical digest of rate submissions and periodic reviews".
This new administrator should also introduce a code of conduct for banks submitting to the rate "as a priority", the report said. This code should contain guidelines for the "explicit use of transaction data" to determine submissions, systems and controls for submitting firms, record-keeping responsibilities and a requirement for regular external audits.
Among more technical proposed changes to the way the rate itself is put together, the report recommends a greater role for those banks which do not currently submit to the rate including, if necessary, "new powers of regulatory compulsion". The BBA and its replacement as administrator should stop compiling the rate in "those currencies and tenors for which there is insufficient trade data to corroborate submissions", and publish individual submissions to the rate after three months in order to reduce the potential for submitting banks to attempt manipulation of the rate.
The report also calls on UK regulators to "work closely" with the international community and "contribute fully" to the debate on the long-term future of the rate, as well as the future of other global benchmarks. The European Commission, for example, has proposed the creation of a specific criminal offence covering the manipulation or attempted manipulation of LIBOR, its Euro equivalent EURIBOR and other reference rates.
Banking law expert Tony Anderson said that any regulatory changes that the Government included in the Financial Services Bill would be "scrutinised carefully", particularly by international markets.
"It is key that the overhaul of LIBOR that is proposed is accepted by the rest of the financial markets throughout the world - it has become far more influential as a global index since it was first introduced in the 1980s, so any changes to LIBOR must be agreed universally to apply," he said. "The transitional changes to deal with the currencies which will no longer be governed by LIBOR such as Australian, Canadian and New Zealand dollars and Danish and Swedish Kronor will create significant workstreams to ensure that workable alternative benchmarks and market-wide solutions can be developed quickly with a minimum of disruption."
Financial Secretary to the Treasury Greg Clark said that Wheatley's report made it "very clear" that self-regulation of LIBOR by banks had "failed".
"LIBOR is a hugely important intentional benchmark and this report makes a series of comprehensive and practical recommendations designed to restore its credibility," he said. "The Government will respond, in full, once Parliament returns."