On one level the decision to award thecontract to administer the London Interbank Offered Rate (Libor) to NYSE Euronext represents an attempt at shrewd short-term politics;
But the move also raises a hornet nest ofquestions over how the entity is to manage inherent and extensive conflicts ofinterests;
What’s more the manner in which the tenderprocess was managed raises alarming questions about the extent to which UK regulatoryagencies have responded to the evidence provided in their own reviews of pastpractice.
On one level the decision to award the contract to administer the Libor to NYSE Euronext represents an attempt at shrewd short-term politics. Given the fact that trillions of dollars in derivative contracts benchmark Libor, how it is calculated, monitored and enforced is critical to rebuilding trust and confidence in market integrity.
Handing control of oversight of what is known as the world’s most important number to an entity about to be taken over by International Continental Exchange (ICE), the world’s largest derivative contract facilitator, links the benchmark to those with a vested interest in protecting its probity. It also raises a hornet nest of questions over how the entity is to manage inherent and extensive conflicts of interests.
The rate will continue to be administered in London through a subsidiary to be registered with the Financial Conduct Authority (FCA). Ultimate ownership in the US has the capacity to integrate its governance with principles currently developed by an International Organization of Securities Commissions task force on global benchmarks, which is co-chaired by the Commodity and Futures Trading Commission (CFTC).
The CFTC is on record as wanting to replace Libor as soon as possible. A benchmark that becomes ‘untethered’ from reality becomes ‘vulnerable to all sorts of misconduct,’ argued Gary Gensler, the chairman of the CFTC in an interview with the Financial Times in April. In the event that the CFTC establishes concrete rules in the US, there is room to develop coordinated policies on benchmark governance, which can then be applied simultaneously in London and New York.
The NYSE-Euronext contract, which it secured for a nominal sum of £1, allows for a continuance of hypothetical submissions when it takes over the administration of the rate next year. The operator will work closely with the FCA to develop new governance and operating procedures, including the move towards observed rates. It remains unclear, however, on what basis these governance and operating procedures will take. And it is on this basis that the conflicts issue moves comes into sharp focus.
See also
Banking sector reform: a definitive guide to the latest developments
ISDAFix: the biggest scandal yet
How regulators plan to curtail rate-setting opt-outs
The tender process revealed both the high level of discretion provided to the administrator and the potential the new administrator has to shape the regulatory agenda. In submission guidelines, the independent tendering body, which is dominated by key city figures, noted that ‘this debate and the implementation of the solutions developed will take time. The new administrator will be able to play a key role in this debate, including through focusing on further steps which could be taken to strengthen Libor.’
The tendering process was overseen by an independent committee led by the cross-bench peer, Baroness Sarah Hogg, the chair of the Financial Reporting Council, which regulates the audit profession in the UK.
Other members of the committee include Paul Fisher of the Bank of England; George Handjinicolaou, Deputy CEO of the International Swaps and Derivatives Association; John Kingman the second permanent secretary at the Department of Treasury; John Stewart, chair of Legal & General and former head of National Australia Bank; and Colin Tyler of the Association of Corporate Treasurers.
Crucially, Martin Wheatley, chief executive of the FCA, was also a member. In governance terms this appears somewhat unusual for two reasons. First, the FCA was given an explicit right to veto the recommendation of the committee. Second, given the centrality of his role the failure to provide granular guidance on what was required to avoid or manage conflicts of interest and ensure the administrator could ensure higher standards represents a stunning failure of oversight.
Eleven criteria were taken into consideration. The proposed methodology, governance and oversight of conduct and operations accounted for 16 % of the evaluation. Tenderers were mandated to include detailed explanations of how they will discourage and detect manipulations and errors in submission to Libor; and will maintain the sustainability of Libor through monitoring for and responding appropriately to risks. In addition there was a requirement to provide declarations of business relationships with Libor panel submitting banks and other relationships with organisations with an interest in Libor, for example organisations whose products use Libor as components of their interests, along with details of how conflicts will be managed.
A further consideration involved an articulation of a plan to assume, maintain and enhance the codes of conduct for persons involved in Libor. This accounted for 8 % of the evaluation. No guidance was provided on the parameters of that code of conduct. In addition, an overall assessment of the Tenderer’s ability to restored credibility to the management of Libor accounted for a further 20 %.
Given the extent to which NYSE –Euronext and ICE itself have deeply embedded relationships with contributing banks and routinely price contracts on the basis of Libor ascertaining how the entity answered these criteria would make for very interesting reading indeed.
The UK response
The manner in which the tender process was managed raises alarming questions about the extent to which regulatory agencies in the UK have responded to the evidence provided in their own reviews of past practice. The Kay report on short-termism emphasised the danger of short-term thinking and the importance of culture. Lacking in concrete recommendations and privileging instead the rebuilding of trust through the articulation of and commitment to common purpose, it remains ineffective.
By contrast the Parliamentary Commission on Banking Standards (PCBS) was equally effective in terms of analysis but much more rigorous in terms of concrete recommendations, the vast majority of which have been ignored. Reliance of voluntary compliance is a strategy explicitly rejected by the PCBS. It however informs the government’s response to the PCBS. It is, perhaps, no accident that the decision on the changed governance of Libor is released as media concentrate, erroneously, in an apparent commitment to bring errant regulators to account. It was particularly revealing that the British Banking Association welcomed and endorsed the government’s response to the PCBS, a response that eviscerates it central message.
Already a senior CFTC commissioner, Bart Chilton was expressed scepticism about the decision. “We had a fox guarding the henhouse issue here and we should learn from that,” Chilton told the New York Times. “I firmly believe that having a truly neutral third-party administrator would be the best alternative, and I’m not sure that an exchange is the proper choice.”
In sharp contrast to the decision by Singapore to scope and police the development of codes of conduct, the tender process in London reflects a continued belief in market ordering. Whether that belief is justified in another matter entirely. It cannot be assured by virtue of a rather opaque tendering process in which the FCA itself is heavily implicated.
Professor Justin O’Brien is Director of the Centre for Law, Markets and Regulation at the University of New South Wales law and an Australian Research Council Future Fellow
See also
Banking sector reform: a definitive guide to the latest developments
Two heads are better than one
ISDAFix: the biggest scandal yet
How regulators plan to curtail rate-setting opt-outs