Benchmarks Under Spotlight as U.K. Gets Tough on Libor

Terry Flanagan

The U.K. continues to push ahead with plans to ramp up market abuse sanctions surrounding benchmarks in the wake of the Libor scandal—which could have far-reaching implications for capital markets.

Following the publication of the Wheatley Review in October, which was set up by the U.K. government in the summer to look at how Libor was calculated and regulated, and the subsequent adoption of the 10-point plan by the U.K. government, the Financial Services Authority has this week proposed new rules and regulations for financial benchmarks that will be implemented by its successor, the Financial Conduct Authority.

“Benchmarks are used across financial markets in a broad range of activities,” said the FSA in a statement. “They have historically been set by the financial markets themselves, and existed outside of any regulatory regime. In the case of Libor, this industry-led approach has failed.”

Many market users, though, are just relieved that the main Libor benchmarks will remain in place with little trading disruption expected. Switching to a new benchmark, as was initially suggested by the Wheatley Review, could have triggered disputes on derivatives contracts worth in excess of $300 trillion. And the potential review of other industry-led benchmarks could have similar ramifications.

“It is important that any reform of rate-setting processes for existing transactions referenced to indices does not disrupt the international capital market,” said David Hiscock, senior director, market practice and regulatory policy at the International Capital Markets Association, a global capital markets self-regulatory organization, in a November 27 letter addressed to the European Commission, which is also conducting its own European Union-wide response to the Libor crisis that is taking in the potential manipulation of all financial benchmarks.

Libor’s future structure, however, will remain an industry-led activity; but the submission to, and administration of, the rate will in the future be regulated by the FCA. Under the overhaul, the number of rates offered will be pruned from 150 to 20—with under-used fixings in the Australian, Canadian and New Zealand dollars, the Danish krone and Swedish krona to disappear entirely. The changes have been met with general approval by the industry.

The tough stance adopted by the U.K.—which is so far going further than that of Brussels—in designing an approach to regulating the setting of benchmarks has left some market participants to wonder if other industry-set benchmarks will be brought under the new rules, which are a wholesale replacement of the current criminal market abuse offense provisions.

“For now, the only benchmark specified is Libor but it will be easy to add new ones by secondary legislation,” said Tim Strong, a partner in the financial disputes team at international law firm Taylor Wessing.

“For example, only three weeks ago the press carried reports of an investigation into attempts to manipulate the benchmark for wholesale gas prices [in the U.K.] and there have been reports of similar allegations for an oil price benchmark. The outcome for those investigations could lead to those benchmarks being added to the list.”

Greg Clark, the U.K. Treasury minister, said: “Recent events have illustrated that Libor might not be the only benchmark subject to attempted manipulation. We are consulting on whether further benchmarks should be brought within the scope of regulation.”

Once the new rules receive royal assent, which is expected in early 2013, criminal charges will then be able to be brought against offenders.

“[This will] provide a significant deterrent to misconduct whilst the European Union civil market abuse proposals, which are being introduced concurrently, run their slow but steady course towards adoption,” said Strong at Taylor Wessing.

He added: “U.K./EU clashes over financial services regulation are obviously not new. It is perhaps ironic, however, that the U.K. has a reputation in Europe for wanting less severe regulation, but following implementation of these proposals it will treat Libor misconduct more severely than the rest of Europe does now or is likely to in the future.”

The integrity of Libor was brought into question in June when Barclays was hit with a record fine of $451 million from regulators in the U.K. and U.S after Britain’s second biggest bank admitted to manipulating Libor from 2005-2009 to the benefit of its derivative positions as well as by a desire to make the bank look stronger during the financial crisis. About a dozen other financial institutions on three continents are also under investigation.

“Confidence and trust are critical to financial markets,” said Martin Wheatley, managing director of the FSA and chief executive designate of the FCA.

“The disturbing events uncovered in the manipulation of Libor have severely damaged that trust. [The new] proposals will bring in clear rules for the setting and governance of benchmarks and are a key step to ensuring the integrity of Libor.”

The Federation of European Securities Exchanges, which lobbies on behalf of 46 of the region’s exchanges, said in a recent consultation document on the regulation of indices that all benchmarks should be brought within the scope of civil and criminal sanctions against manipulation and that the governance, transparency and calculation methodology arrangements for benchmarks “should be subject to a set of high level principles which are being devised by Iosco [an umbrella group of global regulators]” which would ensure “independence and transparency” to the process.

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