Banks dodge Libor-benchmark reform bullet in proposed rules
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Banks dodge Libor-benchmark reform bullet in proposed rules

The European Commission’s latest draft legislation proposal governing financial market benchmarks, released on September 18, reveals that lawmakers have dropped some of the more onerous regulatory requirements that were causing market participants concern over the summer.

Financial-benchmark administrators are satisfied with the way proposed European legislation is evolving.

A leaked proposal, which emerged in June, indicated that the relatively new and thinly staffed European Securities and Markets Authority (ESMA), based in Paris, would assume ultimate authority for setting benchmark rules, establishing codes of conduct for institutions and individuals working on their calculation, and enforcing them on a day-to-day basis.

While this raised the prospect of potential regulatory turf war for any benchmark based on multi-jurisdictional inputs, the situation was of particular concern for the UK’s Financial Conduct Authority (FCA), which had invested substantial resources, along with the International Organization of Securities Commissions.

These bodies were tasked with reviewing what went wrong with Libor, the world’s most referenced financial benchmark, and developing a new regulatory framework to renew confidence after revelations of widespread market abuse during the crisis.

It was a also a concern for NYSE Liffe, the newly mandated Libor administrator, which will take over management duties early next year, and had been working on the basis it would be subject to FCA compliance, not ESMA.

The market therefore spent much of the summer worrying about the potential for conflict.

“There is broad support in Brussels for the [FCA CEO Martin] Wheatley-led changes to Libor but one key point of dispute with the Commission and some member states [centred on] who should supervise Libor,” a Brussels based lobbyist said in July. “The Commission sees supervision of such essential benchmarks as a Union competence and a job for ESMA.”

Where June’s leaked proposal reflected the ambitions of Brussels and activist politicians promoting centralized control of all benchmarks, the official draft is more measured, with the Commission acknowledging the primacy of national agencies’ competence in setting their own rules.

However, ESMA reserves the right to step in if local authorities drop the ball, specifically where critical benchmarks are concerned. The proposals would give ESMA authority to intervene in the day-to-day business of benchmark administrators where European regulators deem a local code of conduct unfit for purpose.

Unlike the proposed FCA code of conduct, ESMA’s code of conduct for benchmark contributors would be legally binding and it remains to be seen whether the EC will hold national regulators to the same standard. The agency will also have the right to impose methodological changes in cases where a subset of contributors is deemed to have disproportionate influence over where a benchmark is set.

As one interested party puts it: “With the official published draft, the market is generally pleased with the direction in which the legislation is moving. It should be noted that this is a draft and it is not the final piece of legislation.

“As the EU Commission is embarking on the legislative process for benchmarks, we cannot predict what the end result will be. According to the draft EU proposal, the FCA will continue to be the lead regulator for Libor, albeit the FCA will be required to form and chair a college of regulators, which it will consult about any major changes in the way the rate is overseen or operates.”

Part of that sanguine attitude could be down to the relatively low expected cost of compliance with the draft rules. According to the Commission’s estimates, each administrator would face average increased compliance costs of just €98,000 under the new rules.

While the FCA and Commodity Futures Trading Commission have shown willingness to make individuals, as well as institutions, liable for Libor manipulation, as demonstrated by criminal charges of wire fraud for three former Icap traders in relation to JPY Libor manipulations between 2006 and 2011, the Commission dropped language from the leaked proposal that would make administrators liable to all end-users.

Of course, the content of the final legislation could well change during the deliberative process and some Brussels politicians continue to push for aggressive regulatory reform, most notably German Green party MEP Sven Giegold.

“The European Parliament must now seek to revise the Commission’s half-hearted proposals, to ensure we have a proper regulatory response to the Libor and Euribor scandals. This implies ensuring European supervision of key benchmarks,” he says on his website.

Thus far, bankers are breathing a rare sigh of relief on a pillar of regulatory reform.

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