Background

Since 1985 when the British Bankers Association (BBA) created and launched the London Interbank Offered Rate (LIBOR) it has become the benchmark for setting rates for a wide range of debt funding and other financial instruments.

In setting daily LIBOR rates the BBA uses data it obtains from a panel of banks for a range of currencies with differing maturities of up to 12 months.  In calculating LIBOR for a given day the BBA ignores the highest and lowest rate quoted for a particular currency and the average rate of the remaining quotes becomes the relevant LIBOR rate for that day.

In some cases rates provided by a bank to the BBA may not in fact reflect the rate for a particular currency on that day as that bank may not have had any reason to borrow in it or more likely it has borrowed in it but not over the whole range of possible maturities (i.e. over night, 7 days, one month etc).  Such a bank may however make reasonable assumptions based on relevant daily data it holds to be able to determine rates it provides to the BBA.  This reliance on a panel of banks and their ability to assume has generated an opportunity for banks to manipulate the data supplied.

LIBOR manipulation

As a consequence of the well documented recent news published on suspected rate manipulation by banks (a number of whom are under investigation by the BBA and other regulatory authorities elsewhere in the world) and fines imposed on Barclays the Government announced the appointment of Martin Wheatley, Chief Executive-designate of the Financial Conduct Authority (FCA), on 2 July 2012 to undertake what is now commonly referred to as the Wheatley review.

On 30 July 2012, HM Treasury published a press release setting out the terms of reference for the Wheatley review of the framework for the setting of LIBOR.

The review is intended to set out a series of recommendations for reforming the current framework for setting and governing LIBOR and will take account of the following key issues:

  • Whether participation in the setting of LIBOR should be a regulated activity
  • The construction of LIBOR, including the feasibility of using actual trade data to set the benchmark
  • The appropriate governance structure for LIBOR
  • The potential for alternative rate-setting processes
  • The financial stability consequences of a move to a new regime and how a transition could be appropriately managed
  • The adequacy and scope of sanctions for tackling LIBOR abuse. In particular, it will look at civil and criminal sanctions relating to financial misconduct, including market abuse and abuse relating to the setting of LIBOR and equivalent rate-setting processes, as well as the FSA’s approved persons regime and investigations into market misconduct.

The review will also consider a range of other issues with respect to other price-setting mechanisms in financial markets.

Timetable

The review timetable includes a discussion paper being published on 10 August 2012 with a stated aim to publish the Wheatley conclusions by the end of September 2012.  The conclusions will then be considered by the government with the intention of legislating through the Financial Services Bill 2012-13.

Commentary

Without attempting to pre-judge the Wheatley recommendations but given the very high volume of instruments and contracts existing within the financial markets that presently use LIBOR as their benchmark it may be most practical, unless it is genuinely believed that LIBOR is tainted beyond redemption, to retain LIBOR on a modified basis rather than replace it with a new system for rate setting.  Devising and introducing a new system (which may not look a whole lot different to LIBOR once implemented) could prove hugely disruptive and create its own uncertainty, both financial and legal, into markets which generally thrive on certainty and could give rise to significant losses and claims.