Wheatley: Libor Needs Strengthening

20 08 2012

The Wheatley Review (the “review”) commissioned by the Chancellor of the Exchequer published its initial discussion paper earlier this month. The Chancellor commissioned Martin Wheatley, the Chief Executive designate of the Financial Conduct Authority to review how the current framework for setting and governing Libor could be reformed. The options included (1) making participation in the setting of Libor a regulated activity; (2) using actual trade data to set Libor; and (3) enhancing transparency in the governance and setting of Libor.

The review’s initial paper – spread over five chapters and three annexes – identifies Libor’s failings and how the benchmark rate could be strengthened. Equally, the review considers the alternatives to using Libor. Moreover, the paper considers the current mechanism and governance of Libor, the criminal sanctions for its manipulation and ends with consultation questions. The questions, which are chapter specific and total fifteen in number, range from do we agree with the review’s analysis of the issues and failings of Libor to should there be an overarching framework for key international reference rates? Responses are requested (within four weeks) by 7 September 2012 to be sent to wheatleyreview@hmtreasury.gsi.gov.uk

The review reiterated that it was commissioned, following reports in the media about the manipulation of Libor and Euribor, under a threefold remit to report on (i) the reforms required to better the existing framework for setting these benchmark rates; (ii) the adequacy and scope of sanctions to appropriately tackle Libor abuse; and (iii) whether analysis of the failings of Libor has implications on other global benchmarks.

Libor is the most widely used benchmark for interest rates worldwide. This is reflected in the rate being referenced in transactions with a minimum outstanding notional value of US $300 trillion. In relation to the overwhelming dependence on Libor as the most widely used benchmark for interest rates internationally, the review considered the benchmark’s credibility to be diminishing. In arriving at its conclusions, the review wrestled with searching for alternatives and it called for called for reform because:

  • Submissions to Libor (which represents unsecured inter-bank term borrowing costs) are reliant on expert judgement rather than transaction data.
  • Incentives – either to indicate their perceived institutional creditworthiness or to prop up trading positions – exist for bankers/banks’ employees to try to manipulate the submissions that compile the rate.
  • The system under which Libor is run leaves chances for contributors to attempt to manipulate submissions in line with their benefit and, therefore, submissions are not always based on transactions. The existing process requires self-policing.
  • Weaknesses in governance arrangements for the compilation process often exist. Thus, stronger oversight, delivered with greater independence and transparency is necessary.

From a governance point of view, the review stated that the present arrangement between BBA Libor, Thomson Reuters and the oversight from the Foreign Exchange and Money Markets Committee (FX&MM) – whose remit includes the design of the benchmark and the governance and scrutiny of all data and panel bank contributions – suffered from “a number of potentially significant limitations” which included “insufficient independence built into these governance structures.”

Acknowledging the serious misconduct that has taken place relating to Libor submissions in recent years, the review found that keeping Libor in its present form wasn’t  “a viable option, given the scale of identified weaknesses and the loss of credibility that it has suffered.” Thus, the review’s solution to the recent chaos was to “significantly” strengthen Libor in light of the above highlighted deficiencies. Moreover, simultaneous action was needed to identify and evaluate alternative benchmarks that could take on some or all or Libor’s current functions.

The review’s initial paper expands upon how Libor could be comprehensively reformed so that the issues identified could be dealt with and confidence in the benchmark could be restored. In sum, strengthening all aspects of Libor’s framework should be considered because:

(1)  The way Libor is calculated needed improvement and more robust and transparent methodologies needed to be adopted. For instance, a trade reporting mechanism could be established to improve the availability of transaction data.

(2)  Governance of the Libor process could be amended to make it more independent, robust and transparent, both within the contributing banks and within the administrator of Libor. A code of conduct could be introduced to establish clear guidelines relating to policies and procedures concerning Libor submissions.

(3)  The regulatory framework could be reformed to bring administration of or submission to Libor within the regulatory purview. Furthermore, if necessary, sanctions could be strengthened.

Insofar as alternatives to Libor were concerned, “any migration to new benchmarks would require a carefully planned and managed transition.” This approach would “limit disruption to the huge volume of outstanding contracts that reference” the ailing London based benchmark. The review made it clear that a shift towards new benchmarks required international coordination and that the UK authorities must take “a leading role in these reforms.”

In respect of Libor’s implications for other benchmarks, the review explained that oil spot prices and financial benchmarks such as Euroibor were being scrutinised and investigated for fitness. The review thought it worthwhile to consider whether a clear set of principles or characteristics that should be applied to all globally used benchmarks existed?

Such characteristics could include:

  • A robust methodology for calculation
  • Credible governance structures
  • An appropriate degree of formal oversight and regulation and
  • Transparency and openness

The review is due to report by the end of the summer. This is to enable any immediate recommendations regarding the regulation of Libor and other benchmarks to be considered by the government in time for any proposals taken forward to be included in the Financial Services Bill (which is currently being considered by the House of Lords). In any event, the review aims to present its findings to the Chancellor of the Exchequer by the end of September.

In relation to criminal prosecutions, it was observed that the existing legislative framework was such that the setting and administration of Libor were not regulated activities under the Financial Services and Regulated Markets Act 2000 (Regulated Activities) Order 2001. Therefore, whilst the Financial Services Authority had initiated regulatory action against firms – under its “Principles for Businesses” – for rigging Libor, the problem is that the FSA was unable to supervise and take enforcement action in relation to such activities because Libor-related activities are not regulated activities. Ultimately, the Financial Services and Markets Act 2000 (“FSMA”) regime did not involve any regulatory requirements relating specifically to setting Libor. Hence, the review noted, “an amendment to Schedule 2 to FSMA may be needed to allow activities in relation to Libor to be brought within regulation under FSMA”.

The review also explained that existing statutory provisions under FSMA and the Fraud Act 2006 were not drafted to secure convictions for manipulating Libor. But comfort was taken in the fact that David Green QC, the Director of the Serious Fraud Office (SFO), was satisfied that existing criminal offences were capable of covering conduct in relation to Libor and related interest rates’ alleged attempted manipulation. The SFO investigation, which involves a number of financial institutions, was announced on 6 July 2012. 

The review’s initial paper is available below


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30 09 2012
Wheatley Review on Resetting Libor « Global Corporate Law

[…] plan to reform the ailing benchmark is on the cards. See earlier posts on Libor on this blog here and here. Moreover, responses to the initial discussion paper are available here, here and here. […]

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