FSA: LIBOR Internal Audit Report

9 03 2013

Punishing banks – Barclays, UBS and RBS – by imposing fines against them for manipulated LIBOR submissions has been a vexing issue for the Financial Services Authority (FSA). After receiving its final notice, Barclays told the Treasury Committee (see Fixing LIBOR: some preliminary findings) that – in order to avoid negative media comment (lowballing) – the issue that firms were making inappropriate LIBOR submissions was raised with the FSA on 13 occasions. Noting media and academic concern, the Treasury Committee highlighted that:

44. Barclays’ continuing manipulation of its own LIBOR setting took place against a background of media concern about the LIBOR setting process during the [financial] crisis. On 25 September 2007, an article by Gillian Tett in the Financial Times entitled “LIBOR’s value called into question” noted the complaint of the Treasurer of one of the largest City banks that “The LIBOR rates are a bit of a fiction. The number on the screen doesn’t always match what we see now.”

45. On 16 April 2008, the Wall Street Journal published an article called “Bankers cast doubt on Key Rate amid crisis” by Carrick Mollenkamp. This noted that: “The concern: Some banks don’t want to report the high rates they’re paying for short-term loans because they don’t want to tip off the market that they’re desperate for cash. The LIBOR system depends on banks to tell the truth about their borrowing rates.

Paragraph 145 of the Barclays’ final notice (for breaching principle 2, principle 3 and principle 5 of the FSA’s Principles for Business) which anonymises identities stated that:

Barclays did raise concerns externally about the LIBOR submissions of other banks (which Barclays perceived to be understated) and on occasion referred to its own approach to submitting LIBOR. However, these comments did not fully explain Barclays’ approach and were inconsistent.

Equally, a Barclays’ LIBOR submitter wrote to manager E saying that (para 171 final notice):

My worry is that we (both Barclays and the contributor bank panel) are being seen to be contributing patently false rates. We are therefore being dishonest by definition and are at risk of damaging our reputation in the market and with the regulators.

The issue was escalated to compliance and management. They responded:

We have consistently been the highest (or one of the two highest) rate providers in recent weeks, but we’re justifiably reluctant to go higher given our recent media experience … [the FSA agreed] that the approach we’ve been adopting seems sensible in the circumstances, so I suggest we maintain the status quo for now.”  

In his evidence, Lord Turner had described chunks of Barclays’ contact with the FSA as “elliptic” and the Treasury Committee found little evidence that Barclays provided the UK authorities with a clear signal about dishonesty at other firms, or its own. Lord Turner confirmed to the Treasury Committee that the FSA’s Internal Audit Department was undertaking a review of how the FSA dealt with the contacts – communications from any firm or from media reports or other information sources which might have provided relevant information – about LIBOR. The review’s objective was to ascertain the suitability of the FSA’s response and make recommendations for future changes.

The Internal Audit Department’s Report covered the period January 2007 to May 2009.  Internal Audit searched 17 million records, reviewed 97,000 documents in detail, and interviewed 20 FSA employees or ex-employees.

The report spotted important areas where the FSA’s performance needed improvement “and makes valuable recommendations for the future, but does not suggest major regulatory failure on the scale identified in the Northern Rock (March 2008) or RBS (December 2011) reports.”

According to the report, from summer 2007 to early 2009, all levels of the FSA’s management had awareness of severe dislocation in the LIBOR market in the period. But the report states that the dislocation was reflective of market conditions, and would have occurred even if lowballing had not occurred.

However, the report sets out numerous instances where the available information provided some indication that lowballing may have occurred.  Of the 97,000 documents reviewed in detail, 26 are judged as providing a direct reference to lowballing or a reference that could have been so interpreted. Two telephone calls from Barclays in March and April 2008 were clear pointers relating to a specific firm: these were included in the FSA’s final notice published on 27 June 2012 in respect of Barclays.

Stemming from this rationale, the report concludes that:

  • The FSA’s focus on dealing with the financial crisis, together with the fact that contributing to and administering LIBOR were not “regulated activities”, led to the FSA being too narrowly focused in its handling of LIBOR related information.
  • Taking the information cumulatively, the likelihood that lowballing was occurring should have been considered.
  • The information received should have been better managed.

FSA chairman Lord Turner commented:

As the financial crisis developed in 2007 to 2008, the FSA’s bank supervisors were primarily focused on ensuring they understood the prudential implications of severe market dislocation. And the FSA had no formal regulatory responsibility for the LIBOR submission process.  As a result, the FSA did not respond rapidly to clues that lowballing might be occurring.  There are important lessons to be learnt about effective handling of information: these are identified in the report and will be taken forward by both the FCA and PRA management. A particularly important lesson is the need to have staff focused on conduct issues even when the world rightly assumes that the biggest immediate concerns are prudential; and vice versa. The new ‘twin peaks’ model of regulation will deliver this.


The report also reveals that while some information was available relating to lowballing, there is, for the period covered, no evidence of any information, direct or indirect, available to the FSA which indicated that traders were manipulating  LIBOR for profit.   All of the authorities, both UK and US and elsewhere only discovered trader manipulation as a by-product of enquiries launched into potential lowballing.  This raises important issues about the regulatory tools best suited to identifying such market manipulation.  More intense supervision may not be the most appropriate lever. Better whistleblowing procedures, greater accountability of top management, and more intense requirements for self-reporting of suspicious activity may turn out to be more effective tools.

As noted earlier on this blog, LIBOR submissions and administration will become regulated activities with an approved persons regime (the first Wheatley recommendation) from 1 April 2013 and the FSA’s successors, together with the new LIBOR administrator (tendering for which began under the Hogg Tendering Committee on 26 February 2013), will agree appropriate market monitoring and oversight for LIBOR. Anyone who wants to gain quick insight into the dilemma/reform of LIBOR and simultaneously desires exposure to a comparative UK/US perspective should read Professor Bainbridge’s Reforming LIBOR: Wheatley Versus The Alternatives. Reading this work as a first step to build up an understanding of the LIBOR conundrum is fruitful because the paper draws together various threads spread across the panoply of documents on the LIBOR issue. The Professor’s verdict is:

Over all, however … analysis of the Wheatley Review strongly suggests that it will prove a viable starting point as a blueprint for reforming LIBOR and other interest rate benchmarks …Yet, the jury remains out on LIBOR’s long-term prospects. Even if the reforms discussed herein lead to a more accurate LIBOR benchmark free from manipulation, LIBOR could still fail if the market for interbank lending remains so depressed as to be unable to generate a sufficient number of actual transactions against which the benchmark can be anchored. Because the Wheatley Review focused only on the former, completing the reform process will require ongoing inputs from monetary policymakers.

But coming back to the report, six lessons are sketched out for the future/successor regulatory authorities which will supersede the FSA, with the arrival of the Financial Services Act 2012 (the cutover date is 1 April 2013): namely, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The report invites them to consider:

(1) Activities outside the regulatory perimeter and their implications

  • Whether there might be other significant non-regulated activities, where wrongdoing by regulated firms in relation to those activities could breach the FCA and PRA Principles for Businesses, pose a threat to the safety and soundness of those firms, or potentially cause significant consumer or market detriment.
  • It has been recommended that FCA and PRA’s senior management consider how such activities will be identified and assessed by the new regulatory authorities’ risk and governance frameworks, so that risk-based prioritisation decisions can be made in relation to them.

(2) Roles and responsibilities      

  • It has been recommended that the FCA should satisfy itself that there is a clear division of responsibilities relating to LIBOR between the authorities (in the new regulatory framework), including for receiving and sharing LIBOR-related information and for acting on that information where necessary.
  • It has been recommended that the FCA (in consultation with the PRA if necessary) should establish clear internal roles and responsibilities relating to LIBOR.

(3) Culture of the regulatory authorities 

  • It has been recommended that FCA and PRA’s senior management embed appropriately the lessons from the Report in the cultures of the regulatory authorities.

(4) How the regulatory authorities use and record information and intelligence 

  • It has been recommended that as an important element in developing the desired culture of the FCA and PRA, alertness to the need to share intelligence appropriately should be reinforced as a principle for all staff behaviour.
  • The report also recommends that the FCA and PRA’s senior management should clarify responsibilities in relation to the use of information from external sources including analysts’ reports, media articles and market data.

(5) Circulating and escalating information       

  • The report recommends that the FCA and PRA establish effective working arrangements for the circulation and sharing of information, including to whom information should be circulated and the action required of the recipient.
  • It has been recommended that the FCA and PRA establish effective working arrangements for the escalation of information to senior management.

(6) Record keeping           

  • It has been recommended that in developing their records management policies, the FCA and PRA include success measures and key performance indicators that take into account the lessons raised in the review and the review’s inherent data limitations. 
  • The lessons to be learned in relation to lowballing include how the FSA might have better interpreted or responded to the information flows which were available at the time.  In relation to derivatives traders however, the report found no evidence to suggest that there were any communications, or, pieces of information which might have alerted FSA staff to this issue.
  • The question raised by the report is whether it would have been feasible to have a supervisory approach in which facts relevant to the derivatives trader issues would have come to light.  It is not clear that it would have been, without an impractically intensive supervisory approach (e.g. regulators cannot have supervisors in every dealing room).  This illustrates that some potential problems cannot be spotted by direct supervision in advance but have to be:

(a)  Policed by firms themselves on a day to day basis;

(b) With effective processes for the supervisory review of firm systems and controls;

(c) Subject to whistleblowing and other procedures to bring problems to light;

(d) Subject to exemplary post facto penalties when offences do occur.



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