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Following the concerns raised about false submissions of bank quotations to form the London interbank offered rate (LIBOR), the independent review set up by the Chancellor of the Exchequer to investigate its regulation published its final report on September 28, 2012.
Chaired by Martin Wheatley, currently managing director of the Financial Services Authority, but also the CEO-designate of the Financial Conduct Authority that will be established next year, ‘The Wheatley Review of LIBOR’ includes a plan for the comprehensive reform of LIBOR.
It is pointed out that recent revelations have demonstrated that the current system of LIBOR is broken and needs a complete overhaul. The concern is that banks have provided estimates of the interest rate at which they would accept offers of funding, both for LIBOR (and for the Euro interbank offered rate), which were different from the rate they would have accepted in practice.
Such benchmarks are used as references for the pricing of many financial instruments such as interest rate swaps and consumer contracts such as mortgages, loans and credit cards. LIBOR and other similar indexes play a key role in the management of risk in the economy, as inter-bank rates influence borrowing costs for many people and companies, being utilized to price some USD550 trillion in loans, securities and derivatives.
It is considered clear that wholesale reform is required to restore credibility in LIBOR as a benchmark, and Wheatley has said that his review “sets out my plans for reforming what has become a broken system and to help restore the trust that has been lost. LIBOR needs to get back to doing what it is supposed to do, rather than what unscrupulous traders and individuals in banks wanted it to do.”
However, he has concluded that LIBOR can be "rehabilitated" through a comprehensive and far-reaching programme of reform. "Although the current system is broken, it is not beyond repair, and it is up to regulators and market participants to work together towards a lasting and sustainable solution.”
The Review sets out a 10-point plan for reform, which includes: new and robust regulation; a fundamental overhaul of the way LIBOR is run, including taking responsibility away from the British Bankers Association (BBA); a requirement for banks to back up their submissions with evidence of relevant transactions; and detailed technical changes to refine the way LIBOR is put together, to make it much harder to manipulate.
The Financial Secretary to the Treasury, Greg Clark, added that the “independent report is very clear – the self-regulation of LIBOR has failed. LIBOR is a hugely important international benchmark and this report makes a series of comprehensive and practical recommendations designed to restore its credibility.”
The UK government is now examining the Review’s recommendations in detail, including the costs and benefits of what has been proposed, and the design and implementation options. It is its intention to introduce any necessary legislation in the Financial Services Bill that is currently under parliamentary consideration.
In particular, however, the government is likely to accept Wheatley’s recommendation that the BBA should transfer responsibility for LIBOR to a new administrator, who will be responsible for compiling and distributing the rate, as well as providing credible internal governance and oversight.
As the BBA acts as the lobby organization for the same submitting banks that they nominally oversee, the report notes that there is a conflict of interest that precludes strong and credible governance and “helped to create the opportunity for misconduct, which in turn discredited LIBOR”.
In response to the Review’s comments, the BBA has strongly stated the need for greater regulatory oversight of LIBOR, and tougher sanctions for those who try to manipulate it. The BBA Council has indicated it would support any recommendation that responsibility for LIBOR should be passed to a new sponsor.
Immediate improvements to LIBOR recommended by Wheatley include that the BBA “should cease the compilation and publication of LIBOR for those currencies and tenors for which there is insufficient trade data to corroborate submissions...(and) publish individual LIBOR submissions after three months to reduce the potential for submitters to attempt manipulation, and to reduce any potential interpretation of submissions as a signal of creditworthiness.”
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