INTRODUCTION
On 28 September 2012, HM Treasury published the
final report on the review of the London Interbank
Offered Rate ("LIBOR") undertaken by Martin
Wheatley, FSA Managing Director and Chief-
Executive designate of the Financial Conduct
Authority (FCA). This follows an initial discussion
paper published by HM Treasury on 10 August 2012
outlining its preliminary thoughts on its review of
LIBOR. The review was tasked with looking at the
structure and governance of LIBOR and to make
recommendations on how the system should be
reformed to ensure that the credibility of this
benchmark could be restored. This can be viewed as a
response to the manipulation of LIBOR rates
undertaken by various banking personnel which came
to light in April 2012.
The summary of the key points of the final report of
the Wheatley Review ("Review") is as follows:
KEY CONCLUSIONS
■ The Review favours comprehensively reforming
LIBOR rather than replacing it.
■ Transaction data should be explicitly used to
support LIBOR submissions.
■ Market participants should continue to play a
significant role in the production and oversight of
LIBOR.
■ The BBA should no longer run LIBOR and there
will be a tendering process for a new administrator.
■ There will be guidelines developed to govern
LIBOR submissions and a Code of Conduct to be
developed and run by the administrator.
■ In the meantime banks, when submitting, should
take into consideration the sort of transactions set
out in the Report when contributing their rates.
■ The submission of rates to LIBOR and the
administration of LIBOR will become regulated
and subject to FSA enforcement and criminal
prosecution.
■ There will be further work internationally with
European, US and other authorities to develop a
global approach to the regulation of LIBOR and
other global benchmarks.
KEY RECOMMENDATIONS
Regulation of LIBOR
1. Making submissions to and the administration
and calculation of LIBOR to become regulated
activities. At present there is no regulatory regime
which covers these activities and this in turn
affects the FSA's ability to supervise and take
enforcement action for contravening these
activities. The Review proposes the government do
this by amending:
LONDON INTERBANK OFFERED RATE (LIBOR)
The Wheatley Review published 28 September 2012
02 | LIBOR
▪ S.22 of Financial Services Markets Act
("FSMA") which sets out the nature of activity
which can be regulated.
▪ Schedule 2 of FSMA which lists the activities that
can be bought under the scope of FSMA
regulation.
▪ Amending the Regulated Activities Order 2011 to
include as regulated activities contributing to and
administering a benchmark, with LIBOR specified
as a relevant benchmark.
2. Submitting and administering LIBOR to become a
controlled function under the FSMA approved
persons regime. Individuals who are making LIBOR
submissions will need to be FSA approved and
satisfy the 'fit and proper' test. The review identifies
senior management, the manager making the
submission or individual submitters as the most
suitable people to perform the controlled function.
3. The submission of false or misleading information
in connection with a benchmark, such as LIBOR,
is a form of market abuse and should come under
the scope of the market abuse regime. As such,
amendments are being proposed by the European
Commission which will prohibit the false or
misleading transmission of information which affects
the calculation of a benchmark. This will be
considered for implementation in the new Market
Abuse Regulation which will replace the existing
Market Abuse Directive.
Institutional Reform
4. The British Banking Association ("BBA") should
transfer responsibility for LIBOR to a new
administrator. The new administrator will be
responsible for compiling and distributing the rate as
well as providing internal governance and oversight.
This should be achieved through a tender process to
be run by an independent committee convened by the
regulatory authorities.
5. The new administrator should fulfil specific
obligations as part of its governance and oversight
of the rate, paying due regard to fairness,
transparency and non-discriminatory access to the
benchmark. The administrator will be responsible
for:
▪ surveillance and scrutiny of submissions;
▪ publishing a statistical digest of rate submissions;
and
▪ periodic reviews to assess whether LIBOR meets
market needs effectively and credibly.
The Rules Governing LIBOR
6. A code of conduct should be drawn up by the
administrator and include:
i) Guidelines for the explicit use of transaction data
to determine submissions, such as:
▪ Guidelines concerning the role and use of inter-
bank deposit transaction data and other transaction
data and other relevant and related markets which
can be used to develop a precise assessment of the
inter-bank funding market.
▪ Detailed procedures for validating submissions
prior to publication and verifying submissions
after publication.
▪ Suspicious submission reporting procedures to be
implemented so that they are reported to the rate
administrator and oversight committee for review.
Any unaccountable or anomalous submissions
should be escalated to the FSA.
▪ Policies for training the LIBOR submitters
including what inputs to take account of when
determining submissions and how to use expert
judgement within the framework of the
submission guidelines.
ii) Systems and controls for submitting companies,
which will include:
▪ An outline of personal responsibilities within each
firm including internal reporting lines and
accountability. LIBOR submitters and associated
managers should be brought under the control of
the function responsible for contributors' liquidity
and liability management. Names of submitters
and personnel within this function have to be
recorded.
▪ Internal procedures to sign off rate submissions,
exception reporting and the provision of
management intelligence.
▪ Implementing disciplinary or whistle-blowing
procedures for attempts to manipulate the LIBOR
submission process (or failing to report this) of
which the FSA will be notified.
▪ Installation of effective conflicts of interest
management procedures and communication
controls both within and between banks and banks
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and other third parties. This will avoid any
inappropriate external influence over those
responsible for submitting rates.
iii) Submitting banks to have responsibility for
transaction record keeping, which will involve:
▪ Keeping accurate and accessible records of
transactions in inter-bank deposits and other
relevant financial instruments (with information
on their currency, maturity, price and counterparty
type).
▪ Records should be readily available to the new
rate administrator and any relevant governance
committees as well as the FSA.
iv) A requirement for regular external auditing for
submitting firms:
▪ The Institute of Chartered Accountants of England
and Wales (ICAEW) are developing guidance for
providing external assurance on interest rate
benchmark submissions.
▪ An annual internal audit and regular compliance
reviews will need be to be implemented. The first
audit is to occur 6 months after the introduction of
the code and then every 2-3 years thereafter.
7. Due to the urgency of the situation the hierarchy
of data described in the Review should be used by
submitting banks until the code of conduct has
been drawn up.
Specifically, submitting banks should use, in
descending order of preference
i) Contributing banks’ transactions in
▪ The unsecured inter-bank deposit market.
▪ Other unsecured deposit markets such as
certificates of deposit and commercial paper.
▪ Other related markets such as overnight index
swaps, repurchase agreements, foreign exchange
forwards, interest rate futures and options and
central bank operations.
ii) Contributing banks' observations of third party
transactions in the same market.
iii) Quotes by third parties offered to contributing
banks in the same markets.
iv) In the absence of transaction data relating to a
specific LIBOR benchmark, expert judgement
should be used to determine a submission.
Submissions may also be adjusted by applying the
following considerations:
▪ Proximity of transactions to time of submission
and the impact of market events between
transactions and submission time.
▪ Techniques for interpolation or extrapolation from
available data.
▪ Changes to the relative credit standing of the
contributor banks and other market participants.
▪ Non-representative transactions.
Improvements to LIBOR Mechanism
8. The BBA should stop the compilation and
publication of LIBOR for those currencies and
tenors for which there is insufficient trade data to
verify submissions. Instead the BBA should
immediately consult with users and submitters to plan
and implement a phased removal of these rates.
9. The BBA should publish LIBOR submissions after
three months. This will reduce the potential for
submitters to attempt manipulation and to reduce the
interpretation of submissions as a sign of
creditworthiness.
10. Banks, including those not currently submitting to
LIBOR, should be encouraged to participate as
widely as possible to compile the LIBOR rate. This
may result in new powers of compulsion so regulators
can require participation from banks who are not
submitting to a LIBOR panel.
11. Market participants using LIBOR should be
encouraged to consider and evaluate their use of
LIBOR. This could involve an analysis of whether
LIBOR is the most appropriate benchmark for the
transactions they are undertaking and whether
standards contracts contain adequate contingency
provisions that cover the possibility of LIBOR not
being produced.
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Institutional Co-ordination
12. The FSA and FCA should work closely with the
European and international community and
participate in the debate concerning the long term
future of LIBOR and other global benchmarks.
These authorities need to work together to establish
and promote clear principles for effective global
benchmarks.
FINAL THOUGHTS AND NEXT STEPS
In the foreword to the final report on the Review of
LIBOR , Martin Wheatley signifies that he and the FSA
and the FCA will be taking the investigation and tackling
of potential LIBOR manipulation very seriously and hint
the issue may merit a wider policy response due to its
international implications.
The Review clearly signals that all the relevant banks
need to undertake a serious reform of their structures,
procedures and policies in respect of their involvement
with benchmarks. These steps will be necessary to avoid
falling foul of the likely new regulatory requirements, if
adopted.
Martin Wheatley clearly concluded that LIBOR was too
widely and deeply embedded as a benchmark in
international markets to be abolished. Ironically
LIBOR's current problems are a consequence of its
international attractiveness as a basis from which a whole
host of interest rate contracts have been calculated -
particularly interest rate swaps globally. In most cases
this was done without the active involvement of those
who were administering LIBOR.
The LIBOR manipulation scandal has, however, brought
to light the extent to which the setting of benchmarks
both domestically and internationally has previously had
little scrutiny from regulators. It is now clear that this
has changed and other benchmarks will be increasingly
scrutinised and subject to regulation.
For firms the focus will be on the new requirements they
will have to fulfil to comply with the Report including
obtaining approval from the FSA for those involved in
the LIBOR rates process, setting up appropriate controls
for this process and complying with the new Code of
Practice once this is promulgated.
If you have any questions about the report, implications
for your business or would like to find out more about our
Financial Services Regulatory expertise, please contact:
Michael McKee
Partner
T +44 (0)20 7153 7468
Simon Wright
Legal Director
T +44 (0)20 7796 6214