Wheatley review discussion paper outlines LIBOR reform initial thinking

Practical Law UK Legal Update 1-520-8565 (Approx. 5 pages)

Wheatley review discussion paper outlines LIBOR reform initial thinking

by PLC Financial Services

Background

The Wheatley review was announced in July 2012 (see Legal update, Chancellor statement on LIBOR and banking reforms) and the terms of reference were published at the end of July (see Legal update, Terms of reference for Wheatley review of LIBOR).

The review is reporting on the following:

Necessary reforms to the current framework for setting and governing LIBOR.
The adequacy and scope of sanctions to appropriately tackle LIBOR abuse.
Whether analysis of the failings of LIBOR has implications on other global benchmarks.

The review is taking place in the context of ongoing investigations into alleged attempted manipulation of LIBOR by a number of UK and overseas authorities. In addition, in July 2012, the Commission announced that it intended to include amendments to its MAD II legislative proposals to ensure that they cover the manipulation of benchmarks, such as LIBOR, and that manipulation of benchmarks is a criminal offence (see Legal update, European Commission publishes amendments extending MAD II to benchmark manipulation).

Options for reform

Strengthening LIBOR. The issues identified could be tackled through significant reform of the existing system. Preserving the LIBOR system would limit the costs of transferring existing contracts, whilst reforms could address failings in the system.
Finding an alternative to LIBOR. If the problems with LIBOR cannot be resolved, new benchmarks could be recommended to replace some or all of LIBOR's role in financial markets.

These options, which are discussed in more detail below, are not mutually exclusive.

Strengthening LIBOR

The discussion paper suggests various ways of strengthening the LIBOR framework:

Improving the mechanism for calculating LIBOR

This would involve making the calculation and compilation methodologies more robust and transparent. For example, a trade reporting mechanism could be established to improve the availability of transaction data.

Amending the governance and oversight of the LIBOR process

This would make the process more independent, robust and transparent, both within the contributing banks and within the LIBOR review and oversight process. For example, a code of conduct could be introduced to establish clear guidelines on policies and procedures concerning LIBOR submissions.

Strengthening the regulatory framework and enhancing the sanctions available to authorities

The LIBOR submission and administration process are not currently regulated activities under the Financial Services and Markets Act 2000 (Regulated Activities Order) 2001 (SI 2001/544) (RAO). Schedule 2 of the Financial Services and Markets Act 2000 (FSMA) could be amended to bring LIBOR-related activities within the scope of regulation. In addition, as LIBOR setting is not a regulated activity, the individuals currently making LIBOR submissions do not have to be approved persons, restricting the FSA's ability to take disciplinary action against individuals.

In terms of options for strengthening sanctions, manipulation or attempted manipulation of LIBOR is generally not covered by the UK civil market abuse regime under section 118 of FSMA, as section 118 is not specifically targeted at the manipulation of benchmarks. However, the Commission is addressing this in its MAD II proposals, as explained above. Manipulation or attempted manipulation of LIBOR is also unlikely to constitute a criminal offence under section 397 of FSMA (misleading statements and practices). Proposals in the paper include widening the scope of section 397 by removing the requirement that the misleading statement or action must have been made for the purpose of inducing another person to act. The paper acknowledges that this would be a potentially significant change that goes beyond LIBOR, and so careful consideration would be needed as to whether this is necessary or proportionate.

The paper explains that the FSA does not currently have the power to investigate related fraud and conspiracy offences, such as fraud by false representation under section 2 of the Fraud Act 2006. However, other authorities, such as the Serious Fraud Office (SFO), are able to take action in relation to these offences.

Alternatives to LIBOR

The paper explains that whatever improvements are made to LIBOR, it is likely that markets will want to consider alternative benchmarks for at least some of the types of transaction that currently rely on LIBOR. In some cases, there are existing rates that could be used more widely. For other types of transaction, new benchmarks may need to be developed. The discussion paper considers three issues:

The nature of the appropriate financial instrument, which would be used to determine an interest rate.
The mechanism or methodology by which the final benchmark is compiled.
The likely costs and impacts of migrating to an alternative rate, given the scale and scope of existing financial contracts that reference LIBOR.

Implications for other benchmarks

The discussion paper notes that the issues identified with LIBOR have broader implications for a range of other benchmarks, both within financial markets and beyond. Some other benchmarks are already under scrutiny: the International Organisation of Securities Commissions (IOSCO) is investigating oil spot prices, whilst the European Commission is reviewing other financial benchmarks, such as EURIBOR. The paper suggests that it is worth considering whether there is a clear set of principles or characteristics that should be applied to all globally used benchmarks. These could include:

A robust methodology for calculation.
Credible governance structures.
An appropriate degree of formal oversight and regulation.
Transparency and openness.

Next steps

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Wheatley review discussion paper outlines LIBOR reform initial thinking | Practical Law