Banking StandardsWritten evidence from the Financial Services Authority

RBS FINE FOR SIGNIFICANT FAILINGS IN RELATION TO LIBOR

1. The Parliamentary Commission on Banking Standards (“PCBS”) will be aware that on 6 February 2013 the FSA together with the US Commodities Futures Trading Commission (“CFTC”) and US Department of Justice (“DoJ”) announced the outcome of its investigation into LIBOR related failings at RBS. In anticipation of the PCBS’s likely interest in this matter, in this memorandum we set out a narrative account of the FSA’s dealings with RBS in relation to LIBOR and other relevant information. We also enclose a copy of the FSA’s Final Notice.

Executive Summary

2. Concerns surfaced in 2008 about LIBOR submissions generally as a result of media articles in the US, and the FSA has had ongoing communications with the CFTC regarding LIBOR since that time. The FSA made initial requests of certain LIBOR panel banks for information relating to the potential suppression of US dollar (“USD”) LIBOR in December 2008. The FSA did not request LIBOR-related information from RBS at this time.

3. Between 2009 and 2010, the FSA examined a large amount of data relevant to certain panel banks’ LIBOR submissions. This data suggested to the FSA that the misconduct in relation to LIBOR took a number of forms and involved a number of banks. From July 2010, the FSA and CFTC began requesting that RBS provide information relating to its LIBOR submissions. Further, between January and June 2011, the FSA commissioned an analysis of the LIBOR submission data in 2007 and 2008 for RBS (and all panel banks) in relation to USD, JPY and GBP (the “Analysis”). The purpose of the Analysis was to identify anomalous submissions made by RBS or other panel banks in order to focus our enquiries. Certain anomalous submissions by RBS were identified by the Analysis and these were followed up by the FSA. In parallel, as a result of work RBS had been doing following requests commencing in July 2010, RBS reported potential misconduct to the FSA between March 2011 and September 2011.

4. RBS was referred to Enforcement for formal investigation on 20 September 2011 and a scoping meeting was held with RBS on 13 October 2011.

Background to LIBOR and the FSA’s Supervision of RBS

5. The FSA refers the PCBS to (i) the UBS memorandum of 7 January which discusses in detail the background to LIBOR and (ii) the FSA’s December 2011 report on the failure of RBS available at www.fsa.gov.uk/static/pubs/other/rbs.pdf (the “RBS Report”) which thoroughly describes the FSA’s supervision of RBS between 2005 and 2008.

6. Since 2009, significant changes have been made to the FSA’s approach to supervision, especially with reference to high impact firms like RBS. The team supervising RBS has increased in number and is organised around the RBS Group structure to provide intensive and intrusive coverage of prudential risks globally and conduct risks within the UK. At the time of RBS requiring Government support FSA Supervision had seven full time equivalent (“FTE”) resources (managers and associates) dedicated to the supervision of RBS. Today, the number stands at 23 FTEs (with 14 on the prudential side and nine on the conduct side).

7. From 2009, the FSA has delivered supervision of RBS through a combination of Advanced Risk Responsive Operating framework (ARROW) risk assessments; core programme reviews (eg on capital, risk management, liquidity and governance); and ad-hoc or reactive pieces, including section 166 reports. The focus has been mainly on prudential risks that could lead to firm failure. As part of this framework the FSA issued two ARROW letters, one in 2009 and one in 2011 (neither made reference to LIBOR). Over the period, the heavy focus on prudential issues was increasingly accompanied by amplified focus on conduct issues (both potential and crystallised risks) such as PPI.

8. During the period between March and September 2011 (when a referral on LIBOR was made to Enforcement), a number of verbal updates were given to FSA Supervision by RBS and its counsel regarding the progress the bank was making in relation to its own LIBOR investigation. RBS also updated FSA Supervision on evidence uncovered relating to the conduct of, and action being taken against, certain individuals.

9. In April 2012, the FSA split its supervision between conduct and prudential supervision in preparation for the legal cutover to the new regulatory regime that will see the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority (“PRA”) replace the FSA in April 2013.

Early Comment Regarding LIBOR

10. From 2007, there were a number of instances where RBS expressed the view in communications with the FSA that LIBOR fixings (but not RBS’s LIBOR submissions) were not representative of actual market activity. These comments were provided in the context of liquidity and market updates.

11. In the second quarter of 2008, a number of media articles were circulated within the FSA which suggested that LIBOR contributors were submitting inappropriate LIBOR fixings (these articles were mainly focussed on “low balling”), including one article which named RBS. Certain of those articles were summarised in Market Update emails circulated by the Bank of England to its own and FSA staff. It should be noted that the investigation has not found evidence of low balling by RBS.

FSA Investigation into RBS’s LIBOR Submissions

12. As noted in paragraph 2, in December 2008, the FSA made requests of certain LIBOR panel banks for information relating to the potential suppression of US dollar (“USD”) LIBOR. The FSA did not request LIBOR-related information from RBS at that time and was not aware of any enquiries by other regulators of RBS at that time.

13. Between 2009 and 2010, the FSA examined a large amount of data relevant to certain panel banks’ LIBOR submissions. This data suggested to the FSA that the misconduct in relation to LIBOR took a number of forms and involved a number of banks. The FSA, as noted in paragraph 3, first sought information (in conjunction with CFTC) from RBS in July 2010. By that point, RBS had commenced an internal investigation which was initially focussed on USD.

14. RBS delivered information to the FSA in a number of instalments during 2010 and beyond.

15. In February 2011, FSA Supervision requested that RBS (and other panel banks) attest to the adequacy of its (then) current systems and controls for the determination and agreement of its LIBOR submissions. RBS provided a positive attestation on 21 March 2011 (discussed in more detail below).

16. Also, between January and June 2011, the FSA commissioned an analysis of the LIBOR submission data in 2007 and 2008 for RBS (and all panel banks) in relation to USD, JPY and GBP (previously defined as the “Analysis”). The results of the Analysis identified 52 anomalous submissions made by RBS. FSA Supervision contacted RBS in June 2011 regarding the anomalous submissions and, in early August 2011, RBS provided a response to the FSA regarding these submissions. In parallel, between March 2011 and early September 2011, RBS reported potential misconduct it was identifying in relation to its JPY, CHF and USD LIBOR submissions.

17. RBS was referred to Enforcement on 20 September 2011 and a scoping meeting was held with RBS on 13 October 2011.

18. The FSA Board was informed of the FSA’s investigation into Barclays in January 2011. The Board were told that the FSA’s investigations into other firms would take place in stages, with investigation of higher risk firms prioritised. The Board was also told of the decision to conduct an analysis of LIBOR submissions made between 2007 and 2008, and were told of the plan to require firms to make an attestation over LIBOR controls. From that point, the FSA Board was, in the normal course of business, kept updated about the overall issues surrounding LIBOR submissions. LIBOR related issues at RBS were only discussed specifically post RBS’s referral to Enforcement during the course of periodic Board updates.

Current Position Regarding RBS’s LIBOR Submissions

19. Part of the failings set out in the FSA Final Notice relate to RBS’s failure to implement proper systems and controls. In particular, reference is made to the fact that RBS was slow to implement adequate systems and controls in part because it failed to identify risks. The FSA found that RBS’s 21 March 2011 attestation was flawed because RBS’s LIBOR-related systems and controls were not adequate at that time. The FSA did not conclude that RBS deliberately misled the FSA with respect to its attestation. However, RBS’s systems and controls were not adequate at the time of the attestation because they did not address the risk that Derivatives Traders would make requests to Primary Submitters.

20. RBS implemented systems and controls in June 2011 that addressed the risk of inappropriate Derivatives Trader influence. However, the less obvious but significant risk that Primary Submitters would consider the impact of LIBOR and RBS’s LIBOR submissions on the profitability of transactions in their money market trading books as a factor in determining RBS’s LIBOR submission, was not addressed until March 2012.

21. RBS has now taken a number of steps to update its processes in relation to its LIBOR-related systems and controls and FSA Supervision continues to monitor the firm to ensure its systems and controls around LIBOR are adequate.

22. In September 2012, FSA Supervision requested and received from RBS a review by its Group Internal Audit of its LIBOR controls. Further, in November 2012, FSA Supervision had further discussions with RBS to ascertain the status of RBS’ governance framework on rate setting and fixing for LIBOR and analogous processes.

23. The FSA imposed a financial penalty of £87.5 million on RBS in connection with its breaches of Principles 3 and 5 of the FSA’s Principles for Businesses. We refer the PCBS to the FSA’s memorandum of 29 January 2013 which details how the FSA determines financial penalties.

Review by FSA Internal Audit

24. As discussed in greater detail in the UBS memorandum, the FSA’s Internal Audit team has been reviewing the FSA’s records to set out the facts relating to contacts with the FSA or awareness within the FSA on the subject of LIBOR manipulation during the period 2007 to 2008. Internal Audit has not found any communications to suggest that the FSA was aware of the manipulation of LIBOR submissions by traders. Internal Audit aims to provide the report to the Treasury Select Committee by the end of March 2013.

25. While the Internal Audit review is not finalised, the FSA has used relevant material arising out of Internal Audit’s review in preparing this memorandum.

6 February 2013

Prepared 19th June 2013