House of Commons - Fixing LIBOR: some preliminary findings

Fixing LIBOR: some preliminary findings - Treasury Contents

1 Introduction

1. On 27 June 2012 the Financial Services Authority (FSA) issued a Final Notice fining Barclays Bank Plc (Barclays) £59.5 million for misconduct relating to the London Interbank Offered Rate (LIBOR) and the Euro Interbank Offered Rate (EURIBOR). This was the largest fine ever imposed by the FSA. It would have been £85 million had not Barclays been given the 30 per cent (stage 1) discount for its co-operation under the FSA's Decision Procedures and Penalties Manual.[1] The FSA investigation operated in co-operation with the US Commodity Futures Trading Commission (CTFC) and Department of Justice (DOJ), which imposed fines of $200 million and $160 million respectively. The misconduct to which the Notice relates lasted from 2005 to 2009.[2] The findings deeply concerned the Treasury Committee, Parliamentary colleagues and constituents.

2. This assessment of LIBOR by the Committee is necessarily a preliminary one. Enforcement proceedings continue both in the UK, where seven firms are being investigated, and in other jurisdictions. The UK Government has requested that the FSA conduct a review into the framework for the setting of LIBOR led by Martin Wheatley, its managing director and Chief Executive-designate of the future Financial Conduct Authority. Parliament has created a cross-party Commission of both Houses to examine the implications of the LIBOR findings for corporate governance and standards in banking. Commissioner Barnier is undertaking regulatory action at a European level. Both the FSA and Barclays are conducting internal reviews.

LIBOR and EURIBOR

3. The FSA has described both the significance of LIBOR and EURIBOR and the process by which it is set. On its significance:

LIBOR and the EURIBOR are benchmark reference rates that indicate the interest rate that banks charge when lending to each other. They are fundamental to the operation of both UK and international financial markets, including markets in interest rate derivatives contracts.

Similarly, the British Bankers Association (BBA), the trade association for banks in the UK, on whose behalf LIBOR is published by Thomson Reuters, notes that "the [LIBOR] rates are also used as the basis for many types of lending, from syndicated and commercial lending, to residential mortgages", and that "it touches everyone from large international conglomerates to small borrowers".[4] LIBOR is also embedded in numerous contracts. Its influence is therefore very significant.

4. LIBOR and EURIBOR are set as follows:

LIBOR is published on behalf of the British Bankers' Association (BBA) and EURIBOR is published on behalf of the European Banking Federation (EBF). LIBOR and EURIBOR are calculated as averages from submissions made by a number of banks selected by the BBA or EBF. There are different panels of banks that contribute submissions for each currency in which LIBOR is published, and for EURIBOR.

LIBOR and EURIBOR are by far the most prevalent benchmark reference rates used in euro, US dollar and sterling OTC [over the counter] interest rate derivatives contracts and exchange traded interest rate contracts. The notional amount outstanding of OTC interest rate derivatives contracts in the first half of 2011 has been estimated at 554 trillion US dollars. The total value of volume of short term interest rate contracts traded on LIFFE in London in 2011 was 477 trillion euro including over 241 trillion euro relating to the three month EURIBOR futures contract (the fourth largest interest rate futures contract by volume in the world).

Until February 2011 the US dollar LIBOR panel consisted of 16 banks and the rate calculation for each maturity excluded the highest four and lowest four submissions. An average of the remaining eight submissions was taken to produce the final published LIBOR.

The BBA told us that since 1 January 2010 LIBOR has been the responsibility of BBA LIBOR Ltd:

BBA LIBOR Ltd undertakes the day-to-day running of the benchmark: liaising with Thomson Reuters, contributors, regulators and users as required. The company is advised by the independent Foreign Exchange and Money Markets (FX&MM) Committee and the LIBOR Ltd. Board. The BBA LIBOR Ltd. Board is separate from that of the BBA.

BBA LIBOR became a limited company (BBA LIBOR Ltd.) with a separate board from the BBA on 1 January 2010. Prior to that BBA LIBOR was part of BBA Enterprises Ltd., a subsidiary of the BBA.

Pre-2010, all technical and rate-related issues were the responsibility of the FX&MM Committee; all contractual arrangements relating to licences were handled by BBA Enterprises Ltd; and the LIBOR Secretariat within the BBA managed relationships with contributing banks and public authorities, provided the Secretariat of the FX&MM Committee, and issued on behalf of the FX&MM Committee any statements and guidance relating to the rates as appropriate. The executive of the BBA brought regular updates on governance issues and related matters to the BBA Board.

FSA findings

5. The FSA found that Barclays' misconduct included:

making submissions which formed part of the LIBOR and EURIBOR setting process that took into account requests from Barclays' interest rate derivatives traders. These traders were motivated by profit and sought to benefit Barclays' trading positions;

seeking to influence the EURIBOR submissions of other banks contributing to the rate setting process; and

reducing its LIBOR submissions during the financial crisis as a result of senior management's concerns over negative media comment.

In addition, the FSA found that "Barclays failed to have adequate systems and controls in place relating to its LIBOR and EURIBOR submissions processes until June 2010 and failed to review its systems and controls at a number of appropriate points. Barclays also failed to deal with issues relating to its LIBOR submissions when these were escalated to Barclays' Investment Banking compliance function in 2007 and 2008".[7]

6. The FSA found that Barclays had "breached Principles 2, 3 and 5 of the FSA's Principles for Businesses through misconduct relating to its submission of rates which formed part of the LIBOR and EURIBOR setting processes. There was a risk that Barclays' misconduct would threaten the integrity of those benchmark reference rates." Principle 2 states that "a firm must conduct its business with due skill, care and diligence". Principle 3 states that "a firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems". Principle 5 states that "a firm must observe proper standards of market conduct".[8]

7. The FSA's acting director of enforcement and financial crime, Tracey McDermott, said at the time of the announcement of its Final Notice:

Barclays' misconduct was serious, widespread and extended over a number of years. The integrity of benchmark reference rates such as LIBOR and EURIBOR is of fundamental importance to both UK and international financial markets. Firms making submissions must not use those submissions as tools to promote their own interests.

The Committee concurs with the FSA's assessment of the importance of the damage done to the benchmark rates by the attempted manipulation that the regulators discovered. Attempted manipulation of these reference rates reduces trust and confidence in markets and carries costs for end users. The Committee is concerned that the FSA was two years behind the US regulatory authorities in initiating its formal LIBOR investigations and that this delay has contributed to the perceived weakness of London in regulating financial markets.

8. The FSA identified two distinct phases of wrongdoing, with different motivations:

Submissions from Barclays from 2005 to 2008 that took into account requests from Barclays' interest rate derivatives traders. These submissions were motivated by profit;
During the financial crisis, from 2007 to 2009, Barclays lowered its LIBOR submissions in response to negative media comment about the bank (often referred to in our evidence as 'low-balling').

These two phases are considered in detail below in sections 2 and 3 of this Report. Mr Bob Diamond, former Chief Executive of Barclays, attempted to subdivide the period of the false submissions during the financial crisis into two phases, one before 29 October 2008, the day Mr Diamond and Mr Paul Tucker, Deputy Governor of the Bank of England (Financial Stability) had a telephone conversation, and the period after that date.[10] The Committee found Mr Diamond's attempt to subdivide the later period of wrongdoing neither relevant nor convincing. It does not appear that the conversation between Mr Tucker and Mr Diamond made a fundamental difference to Barclays' behaviour, given the repeated instances of 'low-balling' submissions to the LIBOR fixing process by Barclays set out in the FSA Final Notice covering the year running up to the phone call between Mr Tucker and Mr Diamond.

9. Barclays may well not be alone. Nor is it likely to be a London-based phenomenon. The FSA is continuing to investigate the conduct of seven other banks in relation to LIBOR—some of them non-UK based banks. The FSA's regulatory counterparts in several other countries are also conducting their own investigations.[11] Barclays is just one of many international banks under investigation for possible market manipulation. It is important that Barclays' serious shortcomings should not be seen in isolation from the possible actions of other banks and we await the results of ongoing investigations.

10. In addition, the Serious Fraud Office (SFO) announced on 6 July 2012 that it had "decided formally to accept the LIBOR matter for investigation".[12] Mr Tucker told us that contingency planning was going on to examine whether "the class action suits [against banks] ... cause such financial damage to the firms that it could undermine stability ... [P]eople are starting to think about that too".[13]

Barclays' co-operation with regulators and early settlement

11. If it proves to be the case that other banks have been guilty of similar misconduct, then Barclays may well have suffered from 'first mover disadvantage'. It has taken the initial brunt of criticism because it settled first and so has been the first bank to have been found guilty of misconduct. Barclays is to be commended for co-operating fully with the regulators' inquiries. The FSA took this into account when determining the penalty:

Tracey McDermott told us that Barclays had "bent over backwards to try to move this forward" and had been "extremely co-operative".[15] The US CFTC, similarly, recognised Barclays' "significant co-operation during the Division of Enforcement's investigation of this matter, which included providing important information and analysis to the Division that helped the Division efficiently and effectively undertake its investigation".[16]

12. Barclays' former Chief Executive, Bob Diamond, told us:

Mr Agius, Barclays' Chairman, told us:

What happened, as we all are in complete common agreement on, was abhorrent and should not have happened. Barclays, when it was first told about the inquiries, co-operated with them. As the inquiries evidently became more serious, our degree of co-operation increased. No one could have co-operated more. We spent as a bank more than £100 million in checking emails and translating Japanese, and so on and so forth. We could not have done more, and that is acknowledged in the submissions of the agencies.

Mr Agius also made clear that Mr Diamond was not involved in any consideration by Barclays of the regulators' inquiries into LIBOR: "Because he was a potential witness, he was excluded from all considerations of these matters [...] he was simply aware that there was an inquiry into LIBOR".[19]

13. However, despite these statements from Mr Diamond and Mr Agius it is important to state that Barclays' internal compliance department was told three times about concerns over LIBOR fixing during the period under consideration and it appears that these warnings were not passed to senior management within the bank. Statements that everything possible was done after the information came to light must be considered against a background of serious failures of the compliance function within the bank. In other words, the senior management should have known earlier and acted earlier.

14. It is noteworthy that the identification of this first period of wrongdoing—the manipulation of submissions in order to benefit traders—came from Barclays' own investigation into the later period of LIBOR fixing during the crisis for Barclays' own benefit. Mr Agius told us that:

15. Asked whether Barclays had been unfairly hit by first-mover disadvantage, Lord Turner, Chairman of the FSA, responded:

16. Barclays received a reduction in its fine because of its high degree of co-operation with the FSA in its investigation. Barclays also disclosed wrongdoing that it had itself found to the regulators. Any such disclosure is likely to have carried serious risk of reputational damage. Co-operation with inquiries needs to be encouraged by regulators, who need to take into account first mover disadvantage, but it does not excuse or diminish wrongdoing. Nor does the fact that others may have been engaged in similar practices. The FSA and its successors should consider greater flexibility in fine levels, levying much heavier penalties on firms which fail fully to co-operate with them. The FSA needs to give high priority to its investigations into other banks, including those largely owned by the taxpayer.

17. Firms must be encouraged also to report to the regulator instances they find of their own misconduct. While such a firm should still be required to pay compensation to any other party who has been disadvantaged by the misconduct, in cases where a firm makes a complete admission of its own culpability the FSA should retain flexibility in setting the fine payable. The FSA should have regard to the desirability of encouraging other firms to confess their misdemeanours in a similar way. The FSA may also need to re-examine its treatment of whistleblowers, both corporate and individual, in order to provide the appropriate incentives for the reporting of wrongdoing.

18. The findings of the regulators have been a reputational disaster for Barclays. They have led directly to the loss of its Chief Executive and its Chief Operating Officer. These resignations were preceded by the announcement of the resignation of its Chairman, who subsequently decided to stay in post until he had overseen the appointment of a new Chief Executive. The resignations at Barclays are considered in section 6 of this Report.

19. The findings have focussed pre-existing public anger with banks. Barclays is one of many instititutions that have contributed to the state of banking's reputation. LIBOR has followed the vast public bailouts of banks during the financial crisis, the liquidity support and guarantees given to all banks and the apparent lack of penalties for those who contributed to that crisis, most of whom retained very high levels of remuneration even after 2008. More recently there has been the scandal of payment protection insurance (PPI) mis-selling, criticism of banks' perceived reluctance to lend, complaints about the sale of unsuitable and complex interest rate swap products to businesses (which are under investigation by the FSA), and serious IT failures at RBS Group. The economy needs well-functioning banks. They will have a crucial role in any economic recovery through their lending to businesses and households. An end to crude 'banker bashing' would be highly desirable, but bankers must recognise that they have brought much of this upon themselves through actions which have seriously damaged public confidence. While banks continue to provide evidence that wrongdoing persists the popular mood is likely to remain hostile.

Policy responses

20. On 2 July 2012 the Chancellor of the Exchequer announced a review ('the Wheatley review') by the FSA of LIBOR:

I have today asked Martin Wheatley, the chief executive designate of the Financial Conduct Authority, to review what reforms are required to the current framework for setting and governing LIBOR. This will include looking at whether participation in the setting of LIBOR should become a regulated activity, at the feasibility of using actual trade data to set the benchmark, and at making initial recommendations on the transparency of the processes surrounding the setting and governance of LIBOR.

The review will also look at the adequacy of the UK's current civil and criminal sanctioning powers, with respect to financial misconduct and market abuse with regard to LIBOR. It will also assess whether those considerations apply to other price-setting mechanisms in financial markets, to ensure that these kinds of abuses cannot occur elsewhere in our financial system. We need to get on with this, and not spend years navel-gazing when we know what has gone wrong. I am therefore pleased to tell the House that Mr Wheatley has agreed to report this summer so that the Financial Services Bill currently before Parliament—or, if necessary, the future legislation on banking reform—can be amended to give our regulators the powers they clearly need.

On 30 July 2012 the Treasury announced the detailed terms of reference of the Wheatley review:

The Wheatley review will formulate policy recommendations with a view to:

1. Reforming the current framework for setting and governing LIBOR. This work should, inter alia, consider:

whether participation in the setting of LIBOR should be brought into the regulatory perimeter under the Financial Services and Markets Act 2000 as a regulated activity;

How LIBOR is constructed, including the feasibility of using of 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.

Determining the adequacy and scope of sanctions to appropriately tackle LIBOR abuse. This work should consider:

2. The scope of the UK authorities' civil and criminal sanctioning powers with respect to financial misconduct, particularly market abuse and abuse relating to the setting of LIBOR and equivalent rate-setting processes; and the FSA's approved persons regime and investigations into market misconduct.

3. Whether similar considerations apply with respect to other price-setting mechanisms in financial markets, and provide provisional policy recommendations in this area.

The review will report by the end of the summer to enable the Government to consider recommendations with a view to taking legislative changes forward through the Financial Services Bill, which is currently being scrutinised in the House of Lords. The review will aim to publish its conclusions by the end of September.[23]

21. Parliament has also instigated a review. On 16 July, the House of Commons created a Parliamentary Commission on Banking Standards to consider and report on:

Professional standards and culture of the UK banking sector, taking account of regulatory and competition investigations into the LIBOR rate-setting process;

In response to the request from the House of Commons, the House of Lords appointed its five members to the Commission on 17 July 2012.[25]

22. On 25 July 2012 the European Commission put forward amendments to proposals for a Regulation and a Directive on insider dealing and market manipulation. The Commission intends that these will "clearly prohibit the manipulation of benchmarks, including LIBOR and EURIBOR, and make such manipulation a criminal offence". Internal Market and Services Commissioner Michel Barnier said:

Committee inquiry

23. In our inquiry we have taken evidence from senior figures in Barclays: Mr Bob Diamond, former Chief Executive, Mr Marcus Agius, Chairman, and Mr Jerry del Missier, former Chief Operating Officer. We held an evidence session with FSA representatives: Lord Turner of Ecchinswell, Executive Chairman, Mr Andrew Bailey, head of the Prudential Business Unit of the FSA, and Tracey McDermott, acting director of Enforcement and Financial Crime. We also heard evidence from Sir Mervyn King, Governor of the Bank of England, and Mr Paul Tucker, Deputy Governor. We thank all the witnesses for making themselves available to give evidence at short notice. The Committee has taken extensive written evidence from many of these witnesses, and from other people and organisations. We are also very grateful for the assistance of our specialist advisers Bill Allen, Jonathan Fisher QC, John Willman and Professor Geoffrey Wood.[27]

24. This Report draws conclusions from the evidence that we have heard and highlight issues for further consideration by Parliament, Government and regulators.

1 See FSA, DEPP 6.7.3, Error! Bookmark not defined. Back

2 Barclays fined £59.5 million for significant failings in relation to LIBOR and EURIBOR, FSA Press Notice, 27 June 2012

Back

3 Barclays fined £59.5 million for significant failings in relation to LIBOR and EURIBOR, FSA Press Notice, 27 June 2012 Back

4 BBA, LIBOR information, 2 July 2012 p 4 and p 16 Back

5 Barclays fined £59.5 million for significant failings in relation to LIBOR and EURIBOR, FSA Press Notice, 27 June 2012 Back

6 Written evidence from the BBA Back

7 Barclays fined £59.5 million for significant failings in relation to LIBOR and EURIBOR, FSA Press Notice, 27 June 2012 Back

8 FSA, Final Notice, 27 June 2012, paras 7, 186, 193 and 196. Back

9 Barclays fined £59.5 million for significant failings in relation to LIBOR and EURIBOR, FSA Press Notice, 27 June 2012 Back

10 Q 21 Back

11 Qq 1167-8; HC Deb, 28 June 2012, col 463 Back