On July 2, 2012, the Chancellor of the Exchequer, Rt. Hon. George Osborne MP, commissioned Martin Wheatley, Managing Director of the U.K. Financial Services Authority (the "FSA") and Chief Executive Designate of the Financial Conduct Authority (one of the successors to the FSA), to undertake a review (the "Wheatley Review") of the structure and governance of LIBOR and the corresponding criminal sanctions regime. On August 10, 2012, Wheatley issued an Initial Discussion Paper setting out the direction of his initial thinking on the necessary reforms and requesting responses to a number of consultation questions by September 7, 2012. On September 28, 2012, Mr. Wheatley and his review team issued their Final Report setting out their recommendations regarding the reformation of LIBOR. The Wheatley Review recommendations will be considered for inclusion in the Financial Services Bill which is currently being considered by the House of Lords.

I. Preservation of LIBOR is Recommended.

The Wheatley Review concludes that there is a clear case in favor of comprehensively reforming LIBOR, rather than replacing the benchmark. Noting that it is estimated that contracts with an outstanding value of at least $300 trillion reference LIBOR, the Wheatley Review determined that a move to replace LIBOR could only be justified by clear evidence that the benchmark is severely damaged, and that a transition to a new, suitable benchmark or benchmarks could be quickly managed to ensure limited disruption to financial markets. The Wheatley Review noted that there has been no noticeable decline in the use of LIBOR by market participants. Indeed a clear majority of market participants responding to the Wheatley Review's consultation argued for the continuation of a form of LIBOR, rather than its wholesale replacement.

II. Regulation of LIBOR.

The Wheatley Review recommends that British authorities introduce statutory regulation of the administration of, and of submissions by banks relating to, LIBOR, including an "Approved Persons" regime, to provide independent supervision, oversight and enforcement, both civil and criminal.

To implement this key reform, the Wheatley Review specifically recommends that:

• administering LIBOR and submitting to LIBOR become regulated activities under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001;
• controlled functions are created in connection with these activities;
• the U.K. government support efforts in the European Union to proceed swiftly with developing and implementing a new civil market abuse regime and open and transparent access to benchmarks; and
• Section 397 of the Financial Services and Markets Act 2000 be amended to enable the FSA to prosecute manipulation or attempted manipulation of LIBOR.

The Wheatley Review concludes that making the acts of submitting to and the administering of LIBOR regulated activities will significantly enhance the FSA's ability to oversee these processes and take action in relation to any misconduct. In particular, it will enhance the ability of the FSA to take the following steps:

• write and implement rules in relation to the LIBOR process, which will set out the systems and controls that a firm must have in place for the production of LIBOR;
• supervise the conduct of the firms and individuals involved in the process, with this supervision including regular reviews of relevant systems and controls in place, as well as the performance of the activities; and
• take regulatory action for misconduct. If a firm does not conduct itself in accordance with either the FSA's Principles for Businesses or any other regulatory requirements in its LIBOR activities, the FSA will be able to impose a public censure or financial penalty, and will in addition be able to impose regulatory requirements on a firm.

III. Strengthening the Administration.

The Wheatley Review recommends that the British Bankers Association (the "BBA") transfer responsibility for LIBOR to a new administrator, who will be responsible for compiling and distributing the rate, as well as providing credible internal governance and oversight. This should be achieved through a tender process to be run by an independent committee convened by the regulatory authorities. The new administrator should fulfill specific obligations as part of its governance and oversight of the rate, having due regard to transparency and fair and non-discriminatory access to the benchmark. These obligations will include surveillance and scrutiny of submissions, publication of a statistical digest of rate submissions, and periodic reviews addressing the issues of whether LIBOR continues to meet market needs effectively and credibly.

IV. Rules and Guidance for LIBOR Submissions.

The Wheatley Review recommends that banks immediately look to comply with the submission guidelines discussed below and make explicit and clear use of transaction data to corroborate their submissions.

The Wheatley Review recommends that LIBOR submissions be determined based upon the hierarchy of transaction types described in 1-4 below. Submitters should use their experience in the inter-bank deposit market and its relationships with other markets to develop their LIBOR submissions. Greatest emphasis should be placed on transactions undertaken by the contributing bank.

1. Contributing banks' transactions in:
   
   
   • the unsecured inter-bank deposit market;
   • other unsecured deposit markets, including but not limited to, certificates of deposit and commercial paper; and
   • other related markets, including but not limited to, overnight index swaps, repurchase agreements, foreign exchange forwards, interest rate futures and options and central bank operations.
     
     
2. Contributing banks' observations of third party transactions in the same markets.
3. Quotes by third parties offered to contributing banks in the same markets.
4. In the absence of transaction data relating to a specific LIBOR benchmark, expert judgment should be used to determine a submission.

Submissions may also include adjustments in consideration of other variables, to ensure the submission is representative of and consistent with the market for inter-bank deposits. In particular, the information obtained above may be adjusted by application of the following considerations:

• Proximity of transactions to time of submission and the impact of market events between transactions and submission time;
• Techniques for interpolation or extrapolation from available data;
• Changes relative credit standing of the contributor banks and other market participants; and
• Non-representative transactions.

The Wheatley Review also recommends that the new administrator of LIBOR adopt a code of conduct which should cover the areas discussed below. The code of conduct should also be published to ensure transparency around the industry guidance for LIBOR submission.

The code should specify, in detail, the process by which submissions are made, including:

• specific and detailed LIBOR submission guidelines; for example, the role and explicit use of inter-bank deposit transactions and other transaction data, and other relevant and related markets which can be used to develop a precise assessment of the inter-bank funding market. Should also include specific aspects that should not be taken into account when determining submissions;
• a requirement to keep accurate and accessible internal records of all transactions in the inter-bank deposit market and other relevant markets, alongside a requirement to provide these records to the rate administrator and oversight committee on a regular basis and on request;
• detailed procedures for validation of submissions prior to publication and corroboration of submissions after publication;
• policies for training of the LIBOR submitter, including what inputs to take into account when determining submissions and how to use expert judgment, within the framework of submission guidelines. Also, should include knowledge of regulatory responsibilities and the code of conduct as outlined. Similarly, should also include training for derivatives traders detailing their potential role in the rate determination, but also outlining types of unacceptable contact with LIBOR submitters; and
• a requirement for all institutions to have in place suspicious submission reporting procedures to the rate administrator and oversight committee for review. Any unaccountable and anomalous submissions should be escalated to the FSA.

The code should also cover, in detail, the requirements and expectations for systems and controls related to the submission process, including:

• an outline of personal responsibilities within each firm, including internal reporting lines and accountability;
• internal procedures for sign-off of rate submissions as well as exception reporting and provision of management intelligence;
• implementing disciplinary and/or whistle-blower procedures for attempts to manipulate or failing to report attempted manipulation by parties external to the LIBOR submission process. Subsequent reporting of misconduct and disciplinary proceedings to the FSA;
• installation of effective conflicts of interest management procedures and communication controls, both within banks and between banks and other third parties to avoid any inappropriate external influence over those responsible for submitting rates. Specifically, LIBOR submitters should be physically separated from interest rate derivatives traders;
• a requirement that all relevant records relating to the submission process be kept;
• requirements for annual internal audit and regular compliance reviews; and
• requirements for external audit, to be first implemented 6 months after introduction of the code, and subsequently every 2-3 years.

V. Reforms to LIBOR Mechanism.

The Wheatley Review recommends that the BBA and, in due course, the new administrator, cease the compilation and publication of LIBOR for those currencies (Australian Dollars, Canadian Dollars, New Zealand Dollars, Danish Kroner and Swedish Kronor) and tenors (4, 5, 7, 8, 10 and 11 months) for which there is insufficient trade data to corroborate submissions, immediately engaging in consultation with users and submitters to plan and implement a phased removal of these rates.

It also recommends that individual LIBOR submissions be published only after 3 months to reduce the potential for submitters to attempt manipulation, and to reduce any potential interpretation of submissions as a signal of creditworthiness.

Furthermore, it recommends that banks, including those not currently submitting to LIBOR, be encouraged to participate as widely as possible in the LIBOR compilation process, including, if necessary, through new legislative powers of regulatory compulsion.

Finally, The Wheatley Review recommends that the new LIBOR administrator publish a regular statistical bulletin detailing the condition of the underlying market. This publication should use the data collected from contributing banks of relevant transactions. In particular, the statistical bulletin should include the volume and value of relevant inter-bank funding transactions and other related financial instruments.

VI. Next Steps.

The Final Report contains a number of recommendations for the British government, the BBA and submitting banks, and the regulatory authorities both in the U.K. and internationally. The British government has already indicated that the Financial Services Bill will be the legislative vehicle for taking forward those recommendations which are accepted. The Bill is currently being considered by the House of Lords.

Under the leadership of Martin Wheatley, the conduct business unit of the FSA, and in particular the markets division, will work closely with the BBA and the banks to ensure that the recommendations addressed to market participants are implemented. Martin Wheatley and the FSA will also continue to engage proactively with international partners in relation to the global debate on benchmarks, working closely with the U.K. Treasury and the Bank of England.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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