Europe poised for showdown with New York over Libor regulation
European regulators are apparently preparing for a regulatory turf war over the reformed Libor benchmark. A draft EU legislative proposal leaked in early June indicates that Brussels feels that Libor falls within its jurisdiction to regulate important market benchmarks, their contributors and their administrators.
The leak will be of particular interest to NYSE Euronext, which last month won a competitive tender run by newly formed UK regulator the Financial Conduct Authority to take over the London Interbank Offered Rate after the UK government stripped the British Bankers’ Association (BBA) of its benchmark administration duties following revelations of abuse during the crisis. NYSE Euronext beat off rival bids from data provider Markit and a Thomson Reuters-London Stock Exchange consortium.
NYSE Euronext CEO Finbar Hutcheson is keen to highlight the importance of repairing public and regulatory confidence in Libor. "Our first priority is to restore confidence and trust in Libor," he says. "For the international capital markets community, Libor is a very important benchmark which the Wheatley Review, the Hogg Committee and ourselves believe must continue."
The issue of confidence is moot for the NYSE Euronext group, given its NYSE Liffe subsidiary’s interest rate derivatives business, which offers several contracts linked to the rate, as Hutcheson notes.
"Libor underpins several of our fixed-income contracts and the markets that our customers and many market participants trade, so it is imperative that trust, integrity and credibility are restored to this benchmark," he adds.
Although the discovery of broad collusion between banks to rig Libor led several regulators to campaign for a new benchmark based directly on observable market rates, Hutcheson says that Libor will remain a dealer-contributed benchmark of offered rates, rather than a function of actual market prices. " We are not proposing an alternative to Libor; we are focusing on strengthening it. We are going to maintain Libor as an inter-bank offered quoted rate, but the submissions of banks will be anchored in the broadest range of relevant transaction data," he notes.
With potential conflicts of interest at the centre of the regulatory challenge, the EU is the third regulatory body to wade into the Libor debate following pronouncements on how the benchmark should be managed from Martin Wheatley, managing director of the Financial Services Authority and the International Organization of Securities Commissions (IOSCO), which both published guidelines earlier this year.
According to Tom White, a research analyst at regulatory think-tank JW Group in London, initiatives to reform Libor have been fragmented from the beginning of the process.
White says: "Unlike the G20 derivatives regulation proposals, market benchmark regulation first emerged at the national level and has since escalated to international supervisory bodies. With respect to the administration of Libor, there are three main regulatory initiatives in play: the Wheatley Review of Libor, the IOSCO principles for benchmarks and the European Union Benchmark Regulation currently in the legislative process.
"As a result, from an outsider’s viewpoint, NYSE appears to be stepping into a struggle for power over Libor regulation, with the implication that the compliance effort could end up in a mess."
NYSE is scheduled to take over administrative duties under the BBA’s new code of conduct in early 2014, but given the nature of some of the EU proposals, could end up having to comply with a new code some time next year.
Although Wheatley, IOSCO and the EU proposals effectively have the same starting point, the devil is in the detail for benchmark users and administrators. Although the differences might be subtle, they might well have practical implications for institutions that have to deliver compliance.
An important area of focus for European regulators is potential liability arising from manipulation of market benchmarks, with some lawmakers arguing that individuals and institutions found guilty of market abuse should be liable for damages to all end users of the benchmark in question. With Libor underlying some $350 trillion of financial instruments, including residential mortgages, there might be a serious downside for rate-setting banks, if this argument continues to carry weight in Brussels.
A Brussels-based lobbyist representing market participants notes that the market will know more about European intentions come mid-September, when the European Commission is expected to publish final draft legislation. Moreover, in forthcoming elections ambitious European parliamentarians might use the issue to enhance their populist credentials. "We might well see profile-seeking legislators pushing radical amendments and onerous restrictions," the lobbyist says. "This is all the more likely given ongoing Commission anti-trust investigation of Forties [oil] and biofuel markets, in which collusion to manipulate benchmarks is alleged. Some legislators who have been active on the Libor issue are actively looking for roles on the legislative proposal."