LIBOR used to be an acronym unfamiliar to most people and of interest to even fewer. Now, though, it has become familiar not just to policymakers and bankers, but also to ordinary businesses and the public.
Understandably so: LIBOR – London Inter-Bank Offered Rate – is one of the most widely used benchmarks for interest rates around the world, serving as a reference in transactions worth more than $300 trillion (€233 trillion). Evidence that its rates were manipulated by traders is, then, of global significance. Moreover, it is of personal significance to millions of individuals, as LIBOR is also used to calculate some mortgage rates and affects the investments of many pension funds.
LIBOR’s reputation has been badly tarnished and the wider financial-services sector is suffering as a result. Reports that other benchmarks have been manipulated suggest a widespread problem. It is absolutely crucial that trust is rebuilt.
In July, the UK’s finance minister commissioned a review of the LIBOR framework from Martin Wheatley, the managing director of the UK’s financial-services regulator. His final report was published on 28 September and should be read by decision-makers beyond London.
Wheatley’s report has put forward three over-arching recommendations and a more detailed ten-point plan. It argues that LIBOR should be reformed rather than replaced; that data on real transactions should be used to support LIBOR submissions (which are estimates) and that market participants should continue to play a key role in the production and oversight of LIBOR.
Michel Barnier, the European commissioner for the internal market, recently called for a global response to the scandals and for tougher sanctions against those caught manipulating submissions. The European Commission also recently launched a public consultation on possible new rules for the production and use of indices as benchmarks in contracts. The recommendations made by Wheatley are lessons that the EU as a whole should, broadly, take on board.
The UK and the EU rule-makers may conclude, unlike Wheatley, that benchmarks that have been manipulated should be replaced rather than reformed. But, whatever the decision, two points should be clear.
Firstly, the process of reform or replacement needs to be delicate. Contracts all over the world are based on LIBOR, so the transition to a new or tweaked system has to be managed very carefully to prevent a further deterioration in confidence. Secondly, better oversight and governance are fundamental to the success and usefulness of the improved benchmark.
One way to restore the public’s and the markets’ confidence in such benchmarks is to have the submissions and processes checked by an independent third party. Wheatley suggests that the new rate administrator should work with the banks to establish a new code of conduct. Banks’ adherence to the code would be audited.
External auditors would also test that there are robust processes to ensure that the figures entered to form the benchmark are accurate. Assurance about processes and about codes of conduct would play a major role in instilling confidence and establishing the credibility of the new or tweaked LIBOR, Wheatley suggests.
The LIBOR scandal revealed a ‘what can I get away with?’ attitude in some parts of the financial industry. This attitude must be uprooted and integrity embedded. Arguably, there is need for a cultural change, across the financial-services sector globally. LIBOR is only one of – unfortunately – several scandals that have emerged. But improving both control over the process of forming interest rates and its transparency have become critical to restoring public confidence in the financial sector.
Iain Coke is the head of the financial-services faculty of the Institute of Chartered Accountants in England and Wales.