In his Mansion House speech on 12 June 2014, Chancellor George Osborne announced a number of measures in light of recently alleged or established market abuses; principally manipulation of benchmarks for forex, gold and, most famously, interest rates (the LIBOR scandal).
We describe below:
- the measures;
- their likely effectiveness;
- timeframes for implementation; and
- possible developments thereafter.
The first announcement in the Chancellor’s speech was a Fair & Effective Markets Review, to be conducted jointly by the Treasury, Bank of England and FCA. The Review will look at standards in three markets: fixed income, currencies and commodities. The Chancellor hinted that laws pursuant to the Review could be sweeping, with some requiring international agreement.
However, he also announced the following changes to the domestic regime, the implementation of which could start immediately:
- The extension of new powers put in place to regulate LIBOR, so that they covered major benchmarks in the three markets mentioned above.
- Extension of the regime introduced last year to tighten up senior bankers’ individual liability for their bank’s misconduct, so that it applies to the UK branches of foreign banks.
- The introduction of new criminal offences for market abuse, rather than opting into European rules.
Their Likely Effectiveness
Mansion House speeches are necessarily light on details. None were given about the proposed new criminal offences.
As for the extension of LIBOR regulations, ten measures were proposed in the September 2012 “Review of LIBOR” by Martin Wheatley, then Managing Director of the FSA. All ten were accepted by HM Treasury, and those requiring primary legislation were introduced in the Financial Services Act 2012. However, not all measures did require legislation, and not all are applicable to other benchmarks, so the scope of the Chancellor’s intentions is unclear.
The main barrier to rolling-out LIBOR measures elsewhere is the fact that the method of its manipulation differed from that alleged of other benchmarks. LIBOR was set by banks estimating what interest rates they would have to pay if they borrowed money. It was a statement of belief, and the manipulation was a misstatement of belief. The allegations around forex, for example, are that the benchmark has been manipulated by actual trades; the trades being just before the daily window when the benchmark is fixed, or during it to nudge it up or down.
One area of extension is likely to be s91 of the Financial Services Act, which makes it a criminal offence punishable by up to 7 years in prison to:
- s91(1): make a misleading statement in the setting of a “relevant” benchmark; or
- s91(2): create a false impression which may affect a “relevant” benchmark.
LIBOR is currently the only benchmark defined as “relevant” under secondary legislation (SI 2013/637). Further secondary legislation could expand the definition.
LIBOR was particularly susceptible to s91(1) “misleading statements”. The same might be said of the London gold fix, a benchmark set twice a day in a conference call between banks. The s91(2) “false impression” offence may be more relevant to benchmarks like forex, set by actual trades.
Whether an extension of s91 would be successful in combatting manipulation largely depends on the method of manipulation; i.e. how easy it is to detect and, therefore, how much appetite for investigation is required. For example, there are two main methods of forex manipulation. “Front-running” is where a bank knows a large order is to be placed at the fix, so it trades on that information beforehand in order to make a profit. This could be relatively relaxed activity compared with “banking the close” which requires a large number of trades in a short period of time around the fix which may be easier to detect.
Other measures implemented for LIBOR, and potentially applicable to other benchmarks are as follows. It is not clear which, if any, the Chancellor meant in his speech:
- That, where a benchmark is administered by a body – e.g. the British Bankers’ Association in the case of LIBOR – this function should be transferred to an independent administrator responsible for scrutiny of the benchmark’s integrity and implementation of a code of conduct.
- That administering the benchmark or making submissions to it be subject to statutory regulation – including an “Approved Persons” regime; i.e. only approved persons should perform key Regulated Activities – to give greater individual accountability and increased regulatory oversight.
Note: in the context of banks (but not other financial institutions) the Approved Persons regime is being replaced by the more stringent Senior Persons regime; which the Chancellor said he was extending to foreign banks operating in the UK.
It was secondary legislation (SI 2013/655) which turned administration of and submissions to LIBOR into Regulated Activities. The Financial Services Act amended FSMA 2000 so as to permit the expansion of the Regulated Activities regime to other benchmarks too.
The Chancellor’s speech set ambitious timelines. He said the Fair and Effective Markets Review would produce its report “in a year’s time”. Of the three changes announced in the speech:
- He said the list of benchmarks to be covered by the extension of LIBOR-type regulation will be published by autumn 2014, and the new regime will be in place by the end of the year.
- The Senior Persons regime is already provided for in Part 4 of the Financial Services (Banking Reform) Act 2013, and is expected to come into force next year. Any delay in implementation of the regime’s extension to foreign banks is unlikely to be long.
- No details were given of the new criminal offences. Timeframes are therefore impossible to estimate. However, as with any current proposals, the Government is incentivised to make progress in advance of the May 2015 general election.
Potential future developments
Light regulation which contributed to the 2007-8 financial crisis is being tightened; the Chancellor’s announcements being the latest example. However, tight regulation has its own risks. As the Chancellor said in his speech, London is home to 40% of global foreign exchange business, 45% of over-the-counter derivatives trading and 70% of trading in international bonds.
Whilst there is a level of inertia that keeps activity in London, there is still a risk that too heavy regulation will reduce the UK’s market share. The Chancellor acknowledged that some of the recommendations from the Fair & Effective Markets Review may require international agreement. Of those that do not, the right balance must be struck between avoiding the perils of under-regulation and the damage to UK competitiveness of over-regulation.
As a separate prediction, the energy sector is slightly behind, but learning from financial markets, for example in forward purchase and derivative contracts. This has led to allegations in that sector too, such as the manipulation of Brent Crude. Regulation in that sector may therefore be tightened, with financial services regulation serving as a model.