UK: Rate Setting and Regulation. In Everyone’s Interests?

Last Updated: 25 September 2012
Article by Rosali Pretorius, Katharine Harle and Madeleine De Remusat

FSA's Final Notice imposing a financial penalty of £59.5 million on Barclays for LIBOR and EURIBOR manipulation has led to intense public scrutiny. FSA's accompanying announcement makes it clear the Final Notice was the product of a cross-border investigation with US authorities including the Commodity Futures Trading Commission (CFTC). A separate announcement confirmed the CFTC brought attempted manipulation and false reporting charges which Barclays admitted and settled for an agreed penalty of $160m. In this article, Rosali Pretorius, Madeleine de Remusat and Katharine Harle of SNR Denton look at the FSA's Final Notice, interest-rate setting and the potential consequences.

FSA Final Notice

Barclays' breaches of FSA requirements arose from it:

  • making submissions as part of the LIBOR setting process that took into account requests from the bank's interest rate derivatives traders seeking to benefit their trading positions; and
  • reducing its LIBOR submissions during the financial crisis as a result of senior management concerns about negative media comment.

The media has focused on each aspect: the former because of the 'colourful' accounts of exchanges between traders and submitters in the Final Notice; the latter because of the contact with the Bank of England which Barclays suggested prompted a direction to reduce the submissions.

The misconduct involved a large number of employees and took place over several years. This continued despite compliance becoming aware of concerns regarding LIBOR submissions in 2007 and 2008. The FSA found that Barclays failed to have adequate systems and controls in place relating to its LIBOR/EURIBOR submissions processes until June 2010 and failed to review its systems and controls at a number of suitable moments. The FSA found this conduct to be in breach of three of its Principles for Businesses:

  • Principle 2: A firm must conduct its business with due skill, care and diligence;
  • Principle 3: A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems; and
  • Principle 5: A firm must observe proper standards of market conduct.

The FSA's acting director of enforcement and financial crime, Tracey McDermott, said:

"Making submissions to try to benefit trading positions is wholly unacceptable. This was possible because Barclays failed to ensure it had proper controls in place. Barclays' behaviour threatened the integrity of the rates with the risk of serious harm to other market participants."

She also commented suggesting that the Barclays Final Notice is not the end of the matter.

"The FSA continues to pursue a number of other significant cross-border investigations in this area and the action we have taken against Barclays should leave firms in no doubt about the serious consequences of this type of failure

" A number of banks are rumoured to be involved in assisting regulators with enquiries. Speculation is rife that Barclays may just be the tip of the iceberg.

LIBOR and rate-setting

So far much of the attention has been on LIBOR; for simplicity this article adopts a similar focus. Note, though, that while the LIBOR/EURIBOR definitions differ, the similarities in the calculation methods and the nature of Barclays' wrongdoing mean that much of the analysis is not exclusive to LIBOR.

LIBOR is the acronym given to the 'London Interbank Offered Rate'. LIBOR is calculated and published by Thomson Reuters on behalf of the British Bankers Association (BBA)1. LIBOR is a benchmark giving an indication of the average rate at which a leading bank would be offered unsecured funding in the London interbank market for a given period, in a given currency. LIBOR is not a measure of just one rate but is produced for ten currencies with 15 maturities quoted for each. The maturities range from overnight to 12 months. This results in a total of 150 rates for each business day. LIBOR is calculated based on the daily responses from a panel of banks2 to the question:

"At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?"3

The number of contributor banks for each rate for both LIBOR and EURIBOR varies but in each case the published rate is the so-called 'shaved mean' - the average of the rates submitted disregarding the lower and higher extremes. For example, for the USD LIBOR there are 18 contributor banks. Reuters discards the highest 4 responses and the lowest 4 responses and the average of the remaining 10 responses is the published LIBOR rate.

LIBOR is recognised as the primary benchmark for short term interest rates globally. On a wider scale, it is used to measure the strain in the money markets and also as an indicator of future central bank interest rates. High LIBOR rates suggest lack of confidence in other banks' liquidity. On a narrower scale, it is also the basis for settling interest rate contracts of many of the world's major future and options exchanges.4 Interest rate derivative contracts typically contain payment terms that refer to benchmark rates. LIBOR is the most prevalent benchmark rate used in euro, US dollar and sterling interest rate derivatives contracts. Benchmark reference rates such as LIBOR also affect payments made under a range of other contracts including loans. So LIBOR matters not just to financial instutions but also, ultimately, to consumers.

The integrity of benchmark reference rates such as LIBOR is of fundamental importance to the integrity of both UK and international financial markets. The Final Notice emphasised this point when justifying the level of financial penalty. The fine is the highest fine ever imposed by the FSA (and would have been £85 million were it not for an early settlement discount).

The consequences

Given the importance of the integrity of LIBOR it is not surprising the potential knock-on consequences of the FSA's Final Notice are both significant and wide ranging in nature. The consequences vary from possible criminal prosecution of individuals to legislative changes not just in respect of LIBOR but also regarding other benchmark rates. We look at a number of these below.


Already there are reports of class action lawsuits underway in the US claiming compensation in respect of losses suffered as a result of LIBOR rigging. In respect of contracts where the amount paid or received was calculated by reference to LIBOR:

  • where LIBOR was allegedly raised by misconduct then the claim is for the additional amounts paid; and
  • where LIBOR was allegedly lowered the claim is for the reduced amount received.

Because of the enormous range and volume of contracts potentially affected this litigation may, if successful, have massive financial implications for the banks concerned. The way in which class actions operate in the US (on the presumption you are included unless you positively choose not to be) and the reduced costs risk associated with an unsuccessful claim tend to suggest that such actions are likely to be less prevalent in England. This is because, although collective action is possible in England, you have to choose to be party to a claim from the outset. There is also a shared risk of adverse costs consequences if the claim fails.

A claimant would need to show that a bank's actions actually caused them loss. Based on the Barclays Final Notice this seems likely to be difficult given the way in which LIBOR is calculated discarding outlying submissions. Barclays' 'proper' submissions would have been so high that they would have been disregarded; even their manipulated submissions were still sufficiently high that their submission would not have been used to calculate LIBOR. So there seems to be no evidence that Barclays' actions actually caused LIBOR to be altered.

Senior management/individual responsibility

Perhaps unsurprisingly, there has been considerable attention on those individuals allegedly involved and public outrage that there is no suggestion of individual prosecutions.

A Treasury Select Committee (TSC) has looked at the limitations of the FSA's powers to prosecute for offences under their existing powers in the Financial Services and Markets Act 2000 (FSMA). On the face of it, section 397 FSMA, which provides for criminal offences of 'misleading statements and practices', would seem to provide the basis for a prosecution. This makes it an offence when a person:

(a) makes a statement, promise or forecast which he knows to be misleading, false or deceptive in a material particular;

(b)dishonestly conceals any material facts whether in connection with a statement, promise or forecast made by him or otherwise; or

(c) recklessly makes (dishonestly or otherwise) a statement, promise or forecast which is misleading, false or deceptive in a material particular.

However, to get a successful conviction the prosecution must show the person concerned acted in order to induce others to:

  • enter, offer to enter, refrain from entering or offering to enter a 'relevant agreement' or
  • exercise or not exercise rights conferred by a 'relevant investment'.

Barclays' LIBOR submissions are neither 'relevant investments' nor 'relevant agreements'. Even if they were, and it is possible that one consequence of the public outcry is that in future they may well be brought within the scope of section 3975, it would be difficult to prove an intention to induce others.

In any event, the FSA's investigation has focussed on what is within its current remit and powers under FSMA. As McDermott has been keen to stress to the TSC, the FSA is not a general fraud prosecutor, and its investigative powers are generally limited to those offences which it is empowered to prosecute. Although it has occasionally brought prosecutions under other legislation alongside FSMA offences6, it does not have the power to specifically investigate such ancillary offences.

FSA has shared the results of its investigation with the Serious Fraud Office (SFO). The SFO can conduct such investigations and is now considering the prospects of bringing individual criminal prosecutions presumably, for the reasons just discussed, under either of the Fraud Act 2006 and the Theft Act 1968 rather than under FSMA. SFO has confirmed it believes existing criminal offences are capable of covering the alleged conduct.

However, offences under both Acts require proof of dishonesty which, on present information, might pose a bar to successfully prosecuting the individuals concerned. In particular, it seems those involved would be likely to contend that the alleged involvement of the Bank of England meant they believed that what they were doing had regulatory consent and so were not acting dishonestly; alternatively they might say this was common practice. How credible such arguments might be will of course largely turn on what evidence there is on both points and the role they might have played in the minds of the individuals concerned.

Another inevitable challenge would be identifying who knew what. Senior individuals would probably argue they were unaware of exactly what was taking place or how their directions had been interpreted. At the other end of the scale, those at working level would probably say they were just following instructions. Section 2 of the Fraud Act 2006 provides that a person is guilty of fraud by false representation where he dishonestly makes a false representation thereby intending, amongst other things, to make a gain for himself or another. In principle, the false submissions potentially meet those requirements. However, a prosecution of a Barclays' submitter would seem unlikely to satisfy the public demand for senior, well-remunerated individuals to be prosecuted.

European and UK legislative proposals

The investigations into the possible manipulation of LIBOR rates have come during a time in which the Commission is introducing proposals for a new Regulation on insider dealing and market manipulation (MAR) together with a Directive on criminal sanctions for insider dealing and market manipulation (CMAD). In direct response to the LIBOR investigations, the Commission has published amendments to MAR and CMAD.

The Commission acknowledges that whilst it may be difficult or impossible for a regulatory authority to prove that manipulation of a benchmark (such as LIBOR) had an effect on the price of related financial instruments, any actual or attempted manipulation of important benchmarks can have a serious impact on market confidence and could result in significant losses for investors and distortions of the real economy. For these reasons, the Commission believes that it is essential that regulatory authorities can impose sanctions for these offences without the need to demonstrate the effects of the offence.

The Commission has amended both MAR and CMAD so that the definition of market manipulation now includes transmitting false or misleading information, providing false or misleading inputs, or any action which manipulates the calculation of a benchmark. The term "benchmark" is defined in CMAD and MAR and includes LIBOR. Unlike other acts which are defined in MAR or CMAD as market manipulation, there is no requirement that the manipulation of the calculation of a benchmark has to be shown to have had an effect.

Separately, in the UK, the Chancellor of the Exchequer has commissioned Martin Wheatley, managing director of the FSA and Chief Executive-designate of the Financial Conduct Authority, to undertake a review of the framework for the setting of LIBOR. The Wheatley Review is to look at a number of issues, including whether the setting of LIBOR should be brought be made a regulated activity under the FSMA, and whether any such extension should include similar rate-setting activities in relation to other rates. A discussion paper will be published on 10 August 2012 with the intention that the Review will publish its conclusions by the end of September.

Other benchmark rates

LIBOR is not the only benchmark rate the calculation of which is now being questioned. The Technical Committee of the International Organisation of Securities Commission (IOSCO) published a consultation report "Functioning and Oversight of Oil Price Reporting Agencies". This report examines the role played by Oil Price Reporting Agencies (PRAs) in the functioning of oil markets, their methods of operation and governance and possible options for future oversight.

Liz Bossley, head of the Consilience Energy Advisory Group says in her submission to IOSCO: "The vast majority of physical oil production moves under contracts that use PRA benchmarks as a reference point", and "perhaps 60 to 70 per cent of OTC swaps and options are priced or cash-settled by reference to PRA quotes". However, the IOSCO report notes the PRAs do not create these indices by using only prices established by actual trades. They also rely on reported quotes from a pool of selected financial players, with sometimes as few as five participants taking part. The PRAs, with their similar calculation process as for LIBOR, would therefore seem to have the same potential weakness for manipulation.

Where next?

It seems inevitable there will be more regulatory action - FSA has clearly set out its stall in respect of ongoing investigations.

It also seems inevitable that future regulation will seek to close the loopholes that allowed misconduct in interest rate setting to take place. The European Commission proposals for amending MAR and CMAD will surely find favour in negotiations with the European Council and Parliament. The Wheatley Review's Terms of Reference reflect the need for UK regulation to address the problems urgently.

One far-reaching further consequence may be a move from rates set using fictional trades to a "real" rate. The Regulation on OTC Derivatives, Central Counterparties and Trade Repositories (known as EMIR) is paving the way for reporting of all trades. The next step would seem to be for trade repositories to work out a rate based on real transaction data.

In the meantime, however, SFO and FSA must act using the powers they have. FSA's first action and the record fine should leave no-one in doubt it will use its current enforcement powers to the fullest extent and continue to take action for breach of Principle. SFO has now stated twice its belief existing criminal law potentially covers the alleged offences. Finally, the powers of regulatory cooperation in cross-border actions should not be forgotten. Two (or more) regulators may in some cases be more powerful than one.

For a summary of the initial proposals from the Wheatley review, please see our separate newsflash.

This article first appeared in Financial Regulation International.


1. EURIBOR is published on behalf of the European Banking Federation (EBF).

2. Including Barclays, HSBC and UBS amongst others.

3. EURIBOR is defined by the EBF as "The rate at which euro interbank term deposits are being offered within the EMU zone by one prime bank to another at 11:00 am Brussels time."

4. Much of this wording is taken from the BBA website overview of LIBOR.

5. McDermott noted before the TSC that the FSMA offences could be redefined so as to capture conduct such as that of Barclays but added that that was something which would need wider consideration to avoid further loophole arising in future.

6. See, for example, the prosecution and conviction in 2010 of Neil Rollins for insider dealing and associated money laundering offences.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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