Resetting LIBOR? Is it Possible or Desirable?

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In an opinion piece posted in September 2012 I discussed the key regulatory reactions in the UK and elsewhere at that stage to the Libor scandal.  Shortly afterwards on 28 September 2012 Mr Martin Wheatley published his final report of The Wheatley Review, which followed his interim report of August 2012. Mr Wheatley was a logical choice for the UK Government to head a review of the manipulation of Libor because he is currently managing director of the Consumer and Markets Business Division of the UK’s Financial Services Authority (FSA).  Also, he is CEO designate of the Financial Conduct Authority (FCA), which will commence its active supervisory role in 2013 when the FSA ceases operation.  The FSA will be replaced by the FCA and the Prudential Regulatory Authority (PRA) the latter will be a subsidiary of the Bank of England.  The PRA will have a general prudential role and, according to briefing documents provided by the government, the FCA: “..will be responsible for regulation of conduct in retail, as well as wholesale, financial markets and the infrastructure that supports those markets. The FCA will also have responsibility for the prudential regulation of firms that do not fall under the PRA’s scope.” Thus the FCA will effectively have a major policing role in the City of London on an ongoing basis and given the corrupt, possible criminal activities that continue to emerge from the Libor scandal, some of that policing role may centre on Libor and whatever successor body to Libor may emerge.

The Wheatley Review, especially its Final Report, seeks to draw a line in the sand for UK regulatory authorities regarding Libor and presents a ten point plan for its reform and future operation.  These ten points centre on: statutory regulation of Libor’s administration and submission processes through the FSA, including amending the Financial Services and Markets Act to allow the FSA to prosecute manipulation or attempted manipulation of Libor; institutional reform of Libor, including transfer of responsibility for Libor away from the British Bankers Association (BBA) and specific governance and oversight obligations for Libor’s new administrator; more explicit and transparent rules governing Libor including a code of conduct for submitters; immediate improvements to Libor, including a reduction in the total numbers of currencies and tenors which reflects the reality of substantive market practice, as well as a three month delay in publishing individual Libor submissions; and an increased emphasis on international co-ordination. The UK Government is expected to support most, if not all of these recommendations, but as Mr Wheatley notes in his Foreword to the Final Report there are other actors including the BBA, the banks, other market participants and the international regulatory community who will have input to the policy discourse on Libor, so there may be other regulatory changes.

In his speech that publicly launched the Final Report Mr Wheatley concluded: “..that LIBOR can be fixed through a comprehensive and far-reaching programme of reform”, that reform is based on the ten point plan summarised above. Mr Wheatley used the analogy of pushing the reset button to encapsulate his proposed reform and re-packaging of Libor.  Time will tell whether the reset button is of a VCR mode symbolising outmoded technology, or of more contemporary digitised smartphone application symbolising that Libor can indeed adapt to changed market and regulatory realities.However, Mr Wheatley was candid about some of the disastrous elements of Libor in recent years.  He acknowledged that: “The key flaw was the inability in the system to manage conflicts of interests..” and that: “…we are not talking about a few rogue individuals here, but a systemic problem.” Mr Wheatley goes on to cite the well-publicised case of the web of traders at Barclays that manipulated Libor.  However, it would be improbable that Barclays were the sole rogue bank regarding manipulation of Libor.  Indeed senior management at Barclays have hinted that several other global banks were engaging in similar or worse behaviour. 

Reports continue to emerge that this may prove to be the case.  For example RBS, which following the Global Financial Crisis (GFC) was bailed out by the UK Government using more than £40 billion of taxpayer funds and is now effectively 82% owned by the British taxpayer.  Mr Tan Chi Min, former head of delta trading in Singapore for RBS has filed a 231-page affidavit with the Singapore High Court which includes transcripts of instant messages from RBS traders and executives about manipulation of Libor.  Mr Tan claims that he was wrongfully dismissed for alleged “gross misconduct” by RBS in December 2011 and made a “scapegoat for malpractice condoned by managers.” RBS has stated that it is “..confident of mounting a successful defence against Mr Tan’s claims.” However, RBS confirmed in August 2012 in its half-yearly results that it was being investigated for manipulation of Libor and its chief executive Mr Stephen Hester: “..has warned that the bank is likely to face fines, like Barclays.”  Deutsche Bank, according to the Guardian,  “..has also admitted that a limited number of its staff were involved in the possible manipulation of Libor rates.  HSBC, Citigroup, JP Morgan Chase and UBS are also under investigation.” Regulatory actors in other jurisdictions including the US and Canada are investigating Libor manipulation.  Indeed there are media reports that: “UBS has already sought to turn whistleblower and apply for immunity from prosecution in Canada.  Court papers filed in the Ontario Superior Court were reported to show that UBS was attempting to negotiate a plea bargain-type deal”.

The global context and repercussions of the Libor scandal are not lost on Mr Wheatley and not just the investigative and possible prosecutorial activities of individual jurisdictions.  He acknowledges that the Libor scandal is not a London issue but a global one.  He recommends that longer term alternatives for Libor should be developed as part of a broader discourse that seeks to develop “…a set of overarching principles that can be applied to all benchmarks.” Such principles are likely to emerge from the work of a range of international regulatory actors including the Financial Stability Board (FSB), the European Commission (EC) and the Bank for International Settlements (BIS), and in particular the International Organisation of Securities Commissions (IOSCO) Task Force on Financial Market Benchmarks (The IOSCO Task Force), of which Mr Wheatley is Co-chair with Mr Gary Gensler, Chairman of the US Commodity Futures Trading Commission (CFTC).

However, whether Libor survives with its current level of global importance is a moot point.  Mr Wheatley admits the fundamental “lack of oversight” which: “In hindsight it now appears untenable for such an important process to be unregulated”. Will, indeed can, the rest of the world trust the UK to administer adequately such an important global benchmark on an ongoing basis?  For example, it has emerged that as long ago as June 2008 the Federal Reserve Bank of New York (FRBNY) sent to Mervyn King, Governor of the Bank of England detailed recommendations to reform Libor and enhance its credibility.  These recommendations included: strengthening Libor’s governance and reporting; eliminating incentives to misreport; and provision of more specific transaction data. If all of the FRBNY recommendations had been substantively implemented from 2008 onwards would the manipulation of Libor have been so pervasive and damaging?

The scale of the pecuniary damage wrought by Libor has yet to be calculated.  Massive legal claims against the relevant banks for damages as a result of manipulation of Libor are likely and some are already in train.  For example, the US city of Baltimore is already a litigant and class action lawyers have described the potential pool of losers from the manipulation of Libor as vast, although proving the relevant counterfactual case is likely to be difficult, protracted and expensive. If successful these claims will generate enormous sums, but perhaps the greatest damage wrought by the Libor scandal has been the destruction of public trust in the finance sector. 

UK Member of Parliament Andrew Tyrie, Chairman of both the Treasury Select Committee and the Parliamentary Commission on Banking Standards expressed it in these terms: “Libor rigging was a shocking scandal.  It is unlikely that such behaviour was restricted to a single bank.  It has also been a catastrophe for the credibility of financial institutions more widely.  The Wheatley Review is a welcome initial step.  If it has got this right, it could mark at least the end of the beginning of the clean-up operation.” It will take time to see if the Wheatley Review has indeed got it right.  However, the effects of the entrenched industry neutralised and routinised deviance now so evident in Libor processes, allied with competitive pressure from other finance centres, the priorities of market actors, the evolution of financial markets themselves, plus associated globalisation influences, may render Libor and any UK-based successor more marginal in future global financial markets, so that any current reset button operation may indeed prove to be more VCR than smartphone in character.  

 

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