International Financial Law, September 2012 – Stephen Gilchrist comments on Wheatley’s Libor Review
Wheatley's Libor Review: what will it achieve?
Author: Daniella Myles | Published: 28th Sep 2012
Questions as to whether criminal sanctions for manipulating the London Interbank Offered Rate (Libor) will have retrospective effect have dominated the market reaction to this morning's release of the Wheatley Libor Review's final report.
While it's clear that those found guilty in the future can be prosecuted, there seems greater interest in whether the penalties can be applied to the banks at the centre of the Libor scandal.
Other key changes, as outlined in Martin Wheatley's speech, include: an actual trades-based system; replacement of the British Bankers' Association (BBA) with a new independent overseer; and people submitting quotes to be approved by the Financial Services Authority (FSA). But criminalising manipulation, and attempted manipulation, has sparked the most interest.
"It has always been clear that criminal sanctions should apply to this sort of disreputable behaviour," said Stephen Gilchrist of Saunders Law.
But a London partner told IFLR today that it's relatively difficult to make criminal sanctions retrospective.
Answering questions from the audience in the morning, Wheatley confirmed that the criminal sanctions regime for manipulation would relate specifically to Libor and not extend to other benchmarks.
He noted that at the European level - via the European Market Abuse Regulation - there would be a broad benchmark test. "If we need to broaden it [Libor rules] out later, then we will do," he said. But this would be a second stage.
The Bank of England governor Mervyn King has welcomed the report's findings, and has urged for the reforms to be introduced as quickly as possible.
Larger bank panel
Under the new Libor-setting process, more banks will be encouraged to submit rates.
In the Q&A session this morning, an audience member cautioned that Libor isn't supposed to represent a market average, but rather represent the rate of the largest bank participants.
He went on to say that it must be clear, to the new overseer, what criteria a bank must satisfy to be asked to submit a quote. He said that contributions from a large number of weaker banks would change the nature of Libor.
The possibility of compelling banks to participate in the process is also somewhat of s shift in regulatory philosophy.
"We are used to seeing banks' permission to engage in certain activities removed, but not compelling them to take on certain activities," said the London partner.
"For crisis and short-term intervention it's not unheard of for regulators to ask banks to become involved to assist them, but this is quite different," they continued.
Importantly, the Charter of Fundamental Rights of the EU includes a right that grants the freedom to conduct a business. Whether requiring a bank to make Libor submissions goes against this right is not clear, however it is something lawyers have began thinking about.
As IFLR reported in July, moving to an actual trades-based system means benchmark rates can be set for only the most liquid indices. This morning Wheatley announced that Libor's existing 150 rates would be whittled down to 20. The 130 rates being scrapped are those for the Australian, Canadian and New Zealand dollars, and the Swedish and Danish Krone.
Certain maturities will be phased out as well, including the four, five, seven, eight, 10 and 11 month rates.
A practical concern that has permeated the Libor debate is what a reformed reference rate would mean for existing contracts. Up to $300 trillion of swaps contracts use the benchmark rate, and significant changes created significant possibilities for market disruption.
Legal advice was taken on the possibility of contract frustration, and whether the benchmark's core definition could change without creating events of frustration and market breakdown.
"I urge you to look at your swaps contracts, they are surprisingly diverse as to what the rate is," Wheatley said, responding to questions from the audience. He noted that sometimes BBA is referenced, sometimes the Libor website is referenced, and so forth.
In this regard, he noted the importance of not changing the core definition.
The London partner told IFLR that the impact on existing contracts is likely to be greater than Wheatley laid out.
Wheatley said despite significant efforts, it was difficult to obtain data from the market about all Libor rates based on currencies and tenors that will be phased out. It means he is not aware of the number of contracts linked to all the indices that cannot be supported be real trade data.
Addressing the prospect of litigation between swaps parties, he said: "We are looking very hard to ensure that won't be a feature of this transition"
Given the preliminary stage of establishing the new Libor regime, Wheatley said it was difficult to describe the scale or exact characteristics of the new agency. But it is clear that it will have a level of independence from the banks submitting.
"Management of conflicts of interest in one thing, but the avoidance is probably better," he said in response to an audience question.
Wheatley doesn't expect the new oversight body to be created solely for the purpose of creating and commercialising the product, rather it will be an existing one.
He made it clear that choosing the new oversight body would not be a commercial tender process. "Our selection process will look very carefully at governance, independence and credibility," he said.
Guidelines will be published regarding the overseer's governance structure, the basics of which are contained in the final report.
When asked why the FSA, or its replacement the Financial Conduct Authority, could not be the overseer, Wheatley responded: "We are not a market operator. We are a regulator, our role is to set rules and supervise those rules."
He said the "day-to-day nitty gritty" tasks required are better suited for a market operator rather than a regulator.
See http://www.hm-treasury.gov.uk/wheatley_review.htm for full details of the Wheatley Review