One could be forgiven for thinking that it was an April Fools’ joke. It wasn’t. On 1 April 2013, the dismantling of the Financial Services Authority (the FSA), the regulatory body of the financial services industry in the United Kingdom, came into effect, leaving behind a legacy of failings. Many will remember the FSA for overseeing the financial crisis and, more recently, the investigation into the manipulation of LIBOR. Robert Sinclair, chief executive of the Association of Mortgage Intermediaries, is quoted to have said, “In looking at whether the FSA achieved its objectives, I doubt there is any independent commentator that would see it as a success.”
The United Kingdom now has a new financial regulatory framework. The FSA has effectively been divided into the Financial Conduct Authority (FCA) and the Prudential Regulation Authority. Another new body, the Financial Policy Committee, has also been introduced. One of the upshots of this new regulatory outlook is a new set of rules and regulations for LIBOR, seen by most as being a direct result of the fixing scandal.
Why all the fuss about LIBOR?
LIBOR is an inter-bank interest rate benchmark, compiled from daily submissions from financial institutions. From 2009, the FSA, along with various other international regulators, started investigating the supposed manipulation of LIBOR. Martin Wheatley, now CEO of the FCA, noted that “Confidence and trust are critical to financial markets” at a time when the markets possessed neither.
Barclays received a hefty fine of £59.5 million from the FSA for admitting its involvement in rigging LIBOR. For its role, the bank has since accumulated fines of around £290 million. Other banks penalised by the FSA included UBS and RBS, which were fined £160 million and £390 million, respectively.
The Serious Fraud Office has also been investigating the LIBOR scandal. It was granted an extra £3.5 million in 2012 for its investigations and last December made three arrests; a clear signal that authorities were looking beyond the global banks and towards individuals to bear the responsibility for malpractice.
However, the efforts to resolve LIBOR manipulations were seen by many as not being enough. With public pressure mounting, there were calls from politicians from all sides that any bankers found to have manipulated LIBOR should face jail. Following the FSA’s admission that it did not have the necessary powers to make that happen, the UK Government responded.
The Wheatley Review
The Government commissioned an independent review of LIBOR on 2 July 2012 to be led by Martin Wheatley. He recognised how engrained LIBOR had become in the financial markets. With there being no obvious superior alternative, the Wheatley Report found that the system, although broken, was not beyond repair. The final Report, published in September 2012, set out a ten point plan for the reform of LIBOR, the crux of which consisted of
- Governance and institutional reform
- Technical changes
- Increased regulation
- Contingency planning.
The criminal regime
In October 2012, the UK Government announced that it accepted the Wheatley Report’s recommendations and set about implementing them.
Three new offences in relation to market manipulation were created, most notably, the offence of making misleading statements or creating a false or misleading impression in relation to specified benchmarks. This new “benchmark” offence is a substantive change and, although currently limited to LIBOR, has scope for other applications in the future. It catches
- Any person who knowingly or recklessly makes a false or misleading statement to another with the intention that the statement is used for setting a relevant benchmark
- Any person who, by a course of conduct, intends to, and knowingly or recklessly creates a false or misleading impression as to the price of any investment or transaction with an interest rate, which may affect the setting of a relevant benchmark.
Two other offences, which largely replicate two recently repealed offences found in Section 397 of the Financial Services and Markets Act 2000 (FSMA 2000), were also introduced as part of the reforms. Interestingly, the restated Section 397 offences for “the making of false or misleading statements” (now Section 89 of the Financial Services Act 2012 (FSA 2012)) and “the creating of false or misleading impressions” (now Section 90 of FSA 2012), have a key addition. Previously, offences were committed only if the accused intended to make a gain for him/herself as a result of the statement or impression. The new offences now also include the concept of making a gain or loss for “another”. On this basis, an employee of a bank could be liable for making a misleading statement with the intent of increasing the bank’s profit, regardless of whether or not the employee would benefit as well.
The new offences, all punishable by imprisonment, certainly appear to be steps in the direction envisaged by Martin Wheatley, who, in his speech to the Association of British Insurers in the Autumn of last year, stated that fines on financial institutions were not sufficient to alter behaviour, individuals must also be held to account.
Historically, and rather surprisingly, the setting of LIBOR rates was unregulated. Perhaps then, in retrospect, it is not surprising that LIBOR-related activities became so rife with abuse. Although the new criminal sanctions seeking to combat this abuse caught many of the headlines, the new powers provided to the FCA are equally noteworthy.
Under the new regime, LIBOR will be regulated: LIBOR-related activities, namely providing information in relation to a specified benchmark and administering a specified benchmark, have become “regulated activities” under FSMA 2000, for which the FCA will be responsible.
To assist the FCA with LIBOR regulation, a number of other key regulatory provisions were also introduced into the FCA’s Market Conduct sourcebook (MAR) as part of the LIBOR reform.
The most notable of these are the following:
- A new benchmark administrator, to be selected by open tender, will take over responsibility for LIBOR from the British Banking Association and will have a much more “hands-on” role in monitoring suspicious activity and corroborating information provided by banks making LIBOR submissions (MAR 8.3).
- Submitting banks are required to have systems that identify and manage conflicts of interest that may arise from the process of making benchmark submissions. The FCA recommends that such a system would include the implementation and maintenance of a clear “conflicts of interest policy” which identifies the circumstances that constitute a conflict of interest arising from benchmark submissions, and the establishment of effective controls to manage any conflicts (MAR 8.2.8).
- Submitting banks are required to appoint an FCA-approved individual responsible for a company’s internal benchmark submission process and to have oversight of the bank’s compliance with the new regulations (MAR 8.2.3(1)).
Many of the new regulations appear to be aimed specifically at avoiding a repeat of the LIBOR manipulation. For example, one of the major issues during LIBOR’s unregulated period was that submitting banks were understating their rates in order to appear in a healthier state than they actually were. In response to this, and in an effort to reduce the potential for false submissions, the Wheatley Review included a further recommendation that individual LIBOR submissions should only be published after three months have elapsed. The British Bankers’ Association has since announced that, while it is still in tenure, it will be fully implementing this recommendation with effect from the July 2013.
The impact of the new criminal legislation may not be known for some time as it does not have retrospective effect. It is, however, a clear signal from the FCA that it will not tolerate financial crime. Coupled with the new regulatory landscape, this displays a robust response by the UK Government to ensure that there is unlikely to be a repeat of the scandal that undermined LIBOR. All of this does, however, come with a cost: start-up costs of £1.6 million for a new administrator and running costs of £1 million a year have been claimed. However, returning to what Martin Wheatley said, confidence and trust are critical in financial markets and, for this to return, these estimated costs may seem a relatively small price to pay.