LIBOR Reform off to Promising Start for Investors
Since Barclays settled with U.K. and U.S. regulators in June over its involvement in the manipulation of LIBOR, investment professionals and other interested stakeholders have waited for the next episode of this scandal to unravel. In the intervening period, it seems that regulators have focused more on the future than the present, with various initiatives underway to fix this broken benchmark. For now, the lurid headlines have given way to more sober pronouncements from policymakers, of which the publication of the U.K.’s Wheatley Review of LIBOR has taken centre stage.
The Wheatley Review, published on 28 September, calls for banks’ LIBOR submissions to be explicitly supported by actual transaction data, along with a new code of conduct over submissions to establish standards over the rate-setting process. That code of conduct will be drawn up by a new administrator who will take over from the British Bankers Association. Other measures include limiting the production of LIBOR to only those currencies and tenors where there is a liquid underlying market and encouraging more banks to participate in the LIBOR process to reduce the influence of any one bank in the calculation of the benchmark. The submission to, and administration of, LIBOR will also be regulated, and the regulator will have powers to pursue criminal sanctions where appropriate.
These recommendations are all positive. In a recent survey, CFA Institute members called for using actual transaction rates as the basis for determining LIBOR, along with stronger regulatory oversight allied with criminal sanctioning powers.
Closing the jurisdictional void over LIBOR is the most obvious step to strengthen investor and consumer protection, particularly through criminal sanctions which act as a credible deterrent to market abuse. More fundamentally, use of actual transaction rates will ensure that the reference rate is anchored in objective, transparent inputs, thereby minimizing the scope for discretion to influence the rate. This is a key step towards strengthening the credibility and robustness of the benchmark. LIBOR rates have become somewhat detached from market reality when one considers the stability of LIBOR relative to other market-based indicators of banks’ credit risk, such as credit default swaps.
So where does this leave us? The Wheatley Review is not the end of the chapter. The European Parliament has been updating its market abuse legislation to define manipulation (actual or attempted) of benchmarks explicitly as a form of market abuse. Meanwhile, the European Commission has launched a public consultation, which closes at the end of November, to examine the production and use of indices serving as benchmarks in financial contracts. This could lead to the creation of a holistic legislative framework for all financial benchmarks and indices. And the International Organization of Securities Commissions (IOSCO) is also in the process of establishing global principles and best practices for the production and use of benchmarks, an initiative co-chaired by Martin Wheatley from the U.K. FSA (and also chair of the Wheatley Review) and Gary Gensler from the U.S. CFTC. The IOSCO initiative is welcomed — 89% of CFA Institute members surveyed agreed that a global framework of key principles or best practices should be developed for internationally used benchmarks.
It has taken a long time since allegations of LIBOR manipulation first surfaced over four years ago, but global regulators finally seem to be giving this issue the attention it deserves. Let’s hope these initiatives keep the lurid headlines at bay.