In September we published a client briefing on the LIBOR Review - key questions and answers. LIBOR, as the key floating interest rate benchmark in the modern financial system, is integral to the operations of the global financial system and an estimated USD300 trillion of existing transactions. In addition to LIBOR-based transactions, an unquantified amount of other transactions reference similar global benchmarks. Following the well-publicised issues in the UK relating to the credibility of LIBOR, the government of the United Kingdom commissioned Martin Wheatley, a managing director at the Financial Services Authority (FSA), to prepare a review of the way LIBOR is managed. The outcome of that review (the Wheatley Review) has now been published. This Briefing summarises its key recommendations, its proposal for a ten point plan and some potential consequences if those recommendations are accepted.
There are three key recommendations:
- That LIBOR should be reformed rather than replaced
- That submissions used for fixing LIBOR should be supported by transactional evidence rather than by estimates
- That market participants should continue to play a significant role in the production and oversight of LIBOR.
The recommendations of the Wheatley Review would have certain consequences if accepted. In summary these are:
- The decision to reform, rather than replace, LIBOR for core maturities and currencies (such as 6 month US Dollar LIBOR) reduces the likelihood that a large number of existing contracts based on such reference rates will need to be renegotiated
- However existing contracts with a reference rate based on LIBOR for a non-core currency (such as Australian or New Zealand Dollars), or any non-core maturity, will need to be renegotiated after allowance for a 12-month transition period
- Banks may need to consider alternative benchmark rates to LIBOR, if those rates are more appropriate, potentially necessitating changes in floating rate pricing procedures
- Those banks that have historically provided quotations for non-core currencies will not be able to do so after the 12-month transition period
- Increased regulation: LIBOR administration is to be regulated by the FSA – existing submitting banks may need to apply for FSA authorisation (or an extension of their existing FSA authorisation) to enable them to continue their submitting activities
- International review and regulatory harmonisation: EU and other international regulators are likely act to harmonise the administration of other benchmarks in the light of the recommendations in the Wheatley Review, resulting in the need for vigilance.
Ten point plan
The Wheatley Review proposes a ten point plan for the comprehensive reform of LIBOR:
- The authorities should introduce statutory regulation of administration of, and submission to, LIBOR. To implement this key reform, the Wheatley Review specifically recommends that:
- administering LIBOR and submitting to LIBOR become regulated activities under the UK Financial Services and Markets Act 2000 (Regulated Activities) Order 2001;
- the UK supports efforts in the EU to proceed swiftly with developing and implementing a new civil market abuse regime and open and transparent access to benchmarks; and
- Section 397 of the UK Financial Services and Markets Act 2000 is amended to enable the FSA to prosecute manipulation or attempted manipulation of LIBOR
- The British Bankers’ Association (BBA) immediately commence a process for tendering out the role of LIBOR administration and governance to an independent party
- The new administrator should fulfil specific obligations as part of its governance and oversight of the rate, having due regard to transparency and fair and non-discriminatory access to the benchmark
- Submitting banks should immediately make explicit and clear use of transaction data to corroborate their submissions, which should be made on the basis of a specified hierarchy of transaction types, the most senior being the unsecured inter-bank deposit market. Submissions should be subject to regular external audits
- The new administrator should, as a priority, introduce a code of conduct for submitting banks
- The BBA should cease the compilation and publication of LIBOR for those currencies and tenors for which there is insufficient trade data to corroborate submissions. Specifically:
- publication of LIBOR for Australian Dollars, Canadian Dollars, Danish Kroner, New Zealand Dollars and Swedish Kronor should be discontinued;
- for remaining currencies, publication of LIBOR for 4, 5, 7, 8, 10 and 11 months tenors should be discontinued; and
- continued publication of overnight, 1 week, 2 weeks, 2 months and 9 months should also be re-considered
- The BBA should publish individual LIBOR submissions after 3 months to reduce the potential for submitters to attempt manipulation and to reduce any potential interpretation of submissions as a signal of creditworthiness
- Banks, including those not currently involved in the submission process, should be encouraged to participate as widely as possible, including, if necessary, through new powers of regulatory compulsion
- Market participants using LIBOR should be encouraged to consider and evaluate their use of LIBOR, including the a consideration of whether LIBOR is the most appropriate benchmark for the transactions that they undertake, and whether standard contracts contain adequate contingency provisions covering the event of LIBOR not being produced
- The UK authorities should work closely with the European and international community and contribute fully to the debate on the long-term future of LIBOR and other global benchmarks, establishing and promoting clear principles for effective global benchmarks
Contracts involving LIBOR in low usage maturities and the five currencies in which LIBOR will be discontinued will be affected and will have to be switched over to alternative benchmarks during a 12 month transition period.
In addition, contracts which refer to the BBA as the rate setter of LIBOR may in due course need to be amended to reflect the identity of the new administrator. Certain existing loan agreements, including those based on the LMA, already provide for the agent to certify an alternative service for quoting LIBOR if the BBA ceases to provide this. Such contracts will not need amending in this regard.
The International Organisation of Securities Commission has already commissioned Martin Wheatley and Gary Gensler, chairman of the US Commodity Future Trading Commission, to examine rate-setting processes for important international pricing benchmarks. That report is likely to build on the Wheatley Report.
The European Commission will publish proposals to improve a range of benchmarks across the EU (including EURIBOR) early next year.
The Japanese Bankers’ association is conducting an ongoing review of the Tokyo Interbank Offered Rate which may use the recommendations in the Wheatley Review as a template.