LIBOR: The Final Nail in the Coffin?

Strong conflict can be observed in the prediction made by Dixit Johsi, who thinks that eliminating the use of LIBOR from the global financial system may present a Herculean task that could be “bigger than Brexit”, and the view espoused by FCA’s boss Andrew Bailey this July in Interest rate benchmark reform: transition to a world without LIBOR who is adamant that the use of the discredited rate must end by 2021. In an earlier speech on the future of LIBOR last July, Bailey stressed the need to transition away from LIBOR and the importance of doing so has not changed. However, Johsi, who is the group treasurer of Deutsche Bank and is also a board member of the International Swaps and Derivatives Association, is of the view that ending the use of LIBOR is a unenviable “mammoth task” which is “bigger than Brexit” on the overall scale of things. In his  speech Bailey reiterated the notorious status that LIBOR had attained after the global financial crisis (GFC) prior to which no one knew of its significance in the global marketplace. “Before then it was largely taken for granted, part of the financial landscape,” it how Bailey put it while stressing that the FCA has regulated LIBOR since April 2013 and that significant improvements have been made in its submission and administration. He said that the reforms of recent years had ensured that no further illegality took place but it was equally Bailey’s position that LIBOR must be terminated in its present form because the absence of active underlying markets raises a serious question about the sustainability of the LIBOR benchmarks that are based upon these markets.

But since “LIBOR is a public good” regulators were eager to protect the the interests of all involved by sustaining the current arrangements until such time as alternatives are available and transition arrangements are sufficiently well advanced. A proxy LIBOR was discussed.  Yet despite the need for a frictionless transition, Bailey is now saying that the time has come to put an end to the use of LIBOR and he therefore stressed that firms should not see phasing out LIBOR as a “black swan” event or a measure of last resort because it is not a “remote probability” and the benchmark’s termination is inevitable. He is pleased with the efforts made to change things thus far but he is not happy about the pace of the transition. The FCA is clear that ensuring that the transition from LIBOR to alternative interest rate benchmarks is orderly will contribute to financial stability and that “misplaced confidence in LIBOR’s survival will do the opposite, by discouraging transition.” Alternatives to LIBOR in the form of SOFR, SONIA, SARON and TONA are already operating globally. The Bank of England has started to publish a reformed and strengthened SONIA. Bailey informed us that it is now supported by an average of 370 transactions per day, compared with 80 before the reform.

Banking and Misconduct: A Critique of the Cure of Culture

Strangely enough, after controversially abandoning a long-awaited revolutionary review of culture in banking, the FCA has started to invoke the mantra of culture yet again. In that regard, Transforming culture in financial services DP18/2 advocates a pressing need for financial firms to clean up their act because cultural complications have been “a key root cause of the major conduct failings that have occurred within the industry in recent history.” Being prescriptive about the panacea of culture is quite an odd thing for the FCA to indulge in yet again. Worse still, the idea that a wider culture is to blame makes a mockery of individual culpability and provokes irresponsibility. The approach is misconceived and fundamentally flawed. Jonathan Davidson, the FCA’s director of supervision, predicts at the outset of the discussion paper that organisational and societal change cannot be brought about by a “quick fix” because of “the complexity of human dynamics.” Events demonstrate that the FCA is in denial about the reality of things. Blaming bad culture has failed as a defence for many people such as Tom Hayes, Jonathan Mathew, Jay Merchant and Alex Pabon who were prosecuted and jailed for benchmark rigging. The FCA’s latest theory is that culture is manageable despite being immeasurable. On any view, this is a fallacious argument because the calculus of culture is not only measurable but has already been clearly recorded as conduct costs, £264 billion between 2012-2016, by the CCP Research Foundation. The systematic arrangement and coding of these costs shows that bad culture and culpability can be readily measured.

Generally, one can only agree with the practical effect of many a cultural mission statement, when everyday conduct, ethics and accountability are what will truly drive good outcomes for customers and engender trust. No issue is taken here on the good work many of the banks are doing in this space. The conduct costs research was never intended to be a means by which to bluntly expose a bank’s conduct costs. Rather, it was to identify a proxy indicator of culture. CCP Research Foundation readily accepts the limitations of this metric. It would further accept that there are many initiatives, controls and/or mitigants that, if properly implemented, would act to promote good behaviour and outcomes for customers; as opposed to shining a light on misconduct post facto. The indirect effect of the capture (and publication) of a firm’s (and/or its peer’s) conduct costs on behaviour is clearly subordinate to such a priori measures. Aside from the lack of guidance and substantive discussion on how to effectively measure and manage common grey area conduct risk, the fact that the regulator is highlighting the culture issue again must, on its face, be applauded. Importantly, any criticisms voiced in this post are my personal views alone.

Benchmark Manipulation and Corporate Crime: Insights on Financial Misconduct

In the second innings things were different. The reverse swinging old ball meant that the Serious Fraud Office’s openers came back to the pavilion with a duck and those charged with misconduct and put in the dock began to eye up the opportunity of scoring a hat trick. Coupled with the reduction in Hayes’s sentence by the Court of Appeal (Lord Thomas of Cwmgiedd CJ, Sir Brian Leveson PQBD and Gloster LJ, see here) on the ground that he was not in a managerial position and suffered from autism, the fact that Darrell Read, Danny Wilkinson and Colin Goodman, Noel Cryan, Jim Gilmour and Terry Farr were found not guilty of LIBOR manipulation casts doubt over future successful prosecutions in benchmark rigging cases. Hamblen J directed the jury to convict the brokers if they had played a “significant” role in helping him rig LIBOR. Apparently they had not. The Court of Appeal’s refusal to grant Hayes permission to appeal to the Supreme Court may provide limited comfort to the SFO but the acquittal of the above brokers charged in the second “sham” LIBOR trial has reversed the momentum gained by the authorities. The brokers’ exoneration exposes the SFO to the accusation that it has been wildly swinging a sledgehammer to smash a nut. So, having tasted blood after Tom Hayes’s conviction, taking a gung-ho approach to weeding out the City’s “bad apples” seems to have backfired because the clever brokers had simply let Hayes believe whatever he wanted.

According to the brokers, the SFO “didn’t investigate it properly and didn’t listen”. Despite big increases to its funding, claims that the SFO’s director David Green QC has overseen a “string of successes” and that the extension of his contract for two years is a “boon” for justice are proving to be totally without merit. These days it is the SFO which is in the dock and Tom Hayes’s tormented father Nick Hayes used the opportunity to defend his son and said: “Today Tom Hayes stands tall. He refused to testify versus the LIBOR brokers and paid the price … I’m proud of him.” Of course, measured against such poor performance, the fact that the embattled agency wants a top-up of £21.5 million in emergency funds for “blockbuster” probes to bolster its dwindling fortunes amounts to expecting rewards for failure; it is completely unjustified.

The New Governor From Canada

Canada’s Mark Carney has had a long and successful career in global banking, finance and regulation. Yet prior to George Osborne’s announcement – just two days ago on 26 November 2012 – that Carney would replace Mervyn King (upon his retirement on 30 June 2013), the Canadian who has become the first foreigner to rise to the position of the Governor of the Bank of England was virtually unknown to the Brits. But Carney, who relishes a challenge, has had a very distinguished career and is currently the Governor of the Bank of Canada and is credited with guarding the Canadian economy against the worst of the global financial crisis. And, since last year, the celebrated regulator with a Goldman Sachs’ background, has also served as the head of the Financial Stability Board: a role which requires his oversight in respect of the regulatory agenda of the Group of 20 leading industrialised and emerging economies.

Here are some of the thoughts that Carney has shared with the media:

• Global systemically important banks have been identified and will be subject to higher capital requirements and mandatory recovery and resolution plans. This framework is also being extended to other systemic financial firms.

Libor: Implementing Wheatley

In the wake of this summer’s scandalous events in the banking sector, the UK government wants to demonstrate that it is acting swiftly to implement the recommendations made by Martin Wheatley – CEO designate of the Financial Conduct Authority – in respect of the London Interbank Offered Rate (“Libor”). To this end, HM Treasury has made clear through Greg Clark (the Financial Secretary) that “the government is committed to restoring global confidence in this important benchmark.” New criminal offences are envisaged for attempted manipulation of Libor and the treasury is looking into bringing other benchmarks within the scope of regulation. Earlier posts on Libor on this blog can be recalled as (1) Treasury Committee on Libor; (2) Libor Needs Strengthening; and (3) Wheatley Review on Resetting Libor .

Some of the proposed changes are set out in the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2013 (“the 2013 order”) which seeks to amend existing legislation contained in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 – (“the 2001 order”) specifying the types of activities and investments for the purposes of the Financial Services and Markets Act 2000 (“the Act”).

Wheatley Review on Resetting Libor

On 28 September 2012, the Wheatley Review of Libor: final report was published and a ten-point 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. The treasury has explained that the government is studying the review’s recommendations and intends to respond to the review by introducing “any necessary legislation” in the Financial Services Bill currently under consideration by the House of Lords.

In his speech Pushing the reset button on Libor, Martin Wheatley – Managing Director of the Financial Services Authority (“FSA”) and Chief Executive-designate of the Financial Conduct Authority – agreed with the Economist’s view that Libor is simply the most important figure in global finance: its centrality in banking law cannot be overstated.

The threefold terms of reference for the review included (1) reforming the current framework for setting and governing Libor (2) determining the adequacy and scope of sanctions to appropriately tackle Libor abuse and (3) whether similar considerations apply with respect to other price-setting mechanisms in financial markets.

Shareholder Democracy, Corporate Governance and Future Reform

Writing on the corporate governance blog earlier this month, Bob Tricker observed that “serious”  interest in corporate governance is a recent phenomenon which only came to the fore following Sir Alan Cadbury’s 1992 Report. The dichotomy is that despite the existence of regulatory bodies such as the US Securities and Exchange Commission since the mid-1930s, it was not until problems such as the Enron scandal, the sub-prime crisis and more recent Libor scandal – that “corporate governance” became a buzzword in the business sphere, company law and regulation.

For Tricker, corporate governance  – to which constructs such as marketing, production, finance, operations research, and management information systems have only recently ceded ground – is quickly becoming the focus of a company’s organisational chart. Themes such as the board of directors, executive directors’ remuneration and their relationship with management are all now very much at the apex of the debate about issues such as shareholder democracy, accountability and transparency in the corporate sphere. It is often said that good corporate governance is about promises kept: Macey, Corporate Governance: Promises Kept, Promises Broken (2010). Conversely, bad corporate governance is considered “promise breaking behaviour”.

Wheatley: Libor Needs Strengthening

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

Treasury Committee’s Views on Libor

London Interbank Offered Rate (Libor) is an average interest rate set by the British Bankers’ Association (BBA). Libor, a benchmark interest rate which the international financial system is wholly dependent, is calculated on the basis of submissions of interest rates by major banks in London and – underpinning approximately US $350 trillion in derivatives – serves as the foundation of global banking and finance. Traders claim that Libor has been manipulated since 1991. Of late, the issue has become a huge scandal because banks either understated or exaggerated (“rigged”) Libor to cast false impressions regarding their creditworthiness or to profit from trades.

The problem was that, rather than overstating or understating figures, banks were required to submit the real/actual rates they were paying or would genuinely pay for borrowing from other banks. Ultimately, an attempt to manipulate Libor violates US law as the rate is widely used in American derivative markets. Moreover, adverse consequences in “fixing” Libor exist for consumers and international markets alike. From Britain’s position, in an economically deteriorating environment, the embarrassment could not have been more unfortunate because Libor is a “London” based exchange rate.