white paper - libor manipulations and regulations (1)

8/10/2019 White Paper - LIBOR Manipulations and Regulations (1)

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Cognizant Business Consulting

LIBOR Reform- Crisis, scandal, response and road ahead

The reputation of the financial services industry has suffered as a result

of the recent LIBOR scandal and some fundamental shifts are

underway in its aftermath. We take a look at what this could mean

for banks and how can they prepare themselves

Executive Summary"This dwarfs by orders of magnitude any financial

scams in the history of markets," said Andrew Lo, a

professor of finance at the Massachusetts Institute of

Technology. He was speaking in response to one of the

worst scandals to hit the financial services industry in

recent times in which some of the major banks were

accused of manipulating the LIBOR London Interbank

Offer Rate or the benchmark rate that determines &

impacts global interest rates. Investigations into the

scandal resulted in penalties of over $2.3billioni for six

major banks notwithstanding major reputationaldamages. Several lawsuits followed and regulators

across the world became involved and initiated

investigation into the scandal.

This paper looks at the major changes being

introduced and provides guidelines for organizations

seeking to plan for and achieve conformance

effectively.

Corporate overview | 2014


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Introduction

At the end of every working day banks in London

determine the rate at which they would be willing to

borrow or lend money from their peers the LIBOR.

What Libor does is formally measure the cost of this

inter-bank lending, setting out the average rate bankspay to borrow from one another. Banks submit

numbers about borrowing in 10 different currencies

across 15 different time periods, such as loans as short

as one day and as long as one year. This mountain of

bank-submitted data is used every day to create

benchmark rates that affect the prices of everything

from credit cards to mortgages to currencies to

commercial loans (both short- and long-term) to swaps.

Since the rates submitted are estimates not actual

transactions it's was relatively easy for traders to

collude and submit false figures which were mutuallyadvantageous than being a true reflection of actual

rates. The scandal broke when it was found that traders

at several banks conspired to influence the Libor by

getting colleagues to submit rates that were either

higher or lower than their actual estimate. Libor was

manipulated both upwards and downward based

entirely on traders position.

InvestigationsInvestigators in the U.S., Europe and Asia have been

probing alleged wrongdoing in the interest-rate-settingprocess for about two years. The EU fined eight global

financial institutions, including for first time two

American banks, to settle charges they colluded to fix

benchmark interest rates.

The tableii iii

below lists some of the major financial

fines imposed by various regulators

Amount Company fined Regulators What was the fine for?

$1.07

billionRaboBank

US CFTCLack of internal controls for mana

submissions

US Justice

departmentTraders requested specific LIBOR

profit

UK FSA Over 500 cases of attempted LIBO

submissions

$453.6 million Barclays

US CFTC Traders schemed for false LIBOR s

US Justice

department

Misconduct in providing false LIBO

fixe rates

UK FCATraders openly discussed requests

rat submissions

$983.7 million Deutsche Bank

European

Commission

Bank acknowledged colluding in se

LIBOR/EURIBOR

14 million ICAP Europe Limited UK FCA For misconduct in setting LIBOR

87.5 million Royal Bank of

Scotland

UK FCATrader colluded with interdealer b

to influence yen LIBOR

US CFTCBank successfully manipulated yen

franc LIBOR

Another dozen banks remain under investigation.

Regulators also realized the gaps and loopholes in the

submission process for key benchmark rates andinitiated a series of reform to overhaul the system,

increase trust and to reduce risk in the system.


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Libor ReformFinancial regulatory bodies across the world including

the International Organization of Securities

Commissions (IOSCO), British Bankers Association

(BBA) and BIS joined in a coordinated effort toward

reference rates reform in the wake of the LIBOR

scandal. This meant that LIBOR submission itself

became a regulated activityiv

and the government of

United Kingdom commissioned Martin Wheatley, a

managing director at the Financial Services Authority

(FSA), to undertake a review of the framework for the

setting of LIBOR. This came to be to known as the

Wheatley review.

The Wheatley Review set out a LIBOR code of conduct

that sought to restore the confidence in the benchmark

rates. Among calls for disbanding the key benchmark

rate, the code of conduct decided to maintain LIBOR

but has a regulated practice. It introduced the

following normsv

in the submission process

1. Governance arrangements: It was required of

banks to establish and maintain effective

organizational and governance arrangement

for the process of making benchmark

submissions. This structure was to cover the

reporting and operating procedures,

oversight and monitoring arrangements,

escalation process and documentation of

business continuity arrangements.

It also required formal designation ofindividuals involved in the submission

process and having a reviewer who is

accountable for the process of generating

and submitting daily LIBOR submissions.

It tasked the banks with creation of policies

and systems that is to be applied uniformly

across all divisions and to submit for review

by regulators

2. Staff Training and Awareness: The legislation

calls for rate submitters and reviewers to

have appropriate experience levels in the

responsibilities they are to perform.

Furthermore, training should be aptlydesigned and assigned to submitters so as to

cover processes, systems and controls

associated with setting of LIBOR. The

training must include inputs required while

making a submission, the impropriety of

attempting to influence rates and the

consequences of fraud. All traders who

primarily deal in products that reference

LIBOR should receive training to ensure

familiarity with the responsibilities, systems

and controls associated with being a

contributing bank.3. Submission methodology: Contributing

banks must ensure that its LIBOR

submissions are determined using effective

methodology to establish the benchmark

submission on basis of objective rules and

relevant information. A contributing bank

must also publish and review the

methodology at least every quarter to

maintain a robust submission process. An

effective LIBOR submissions methodology

should have clear quantitative criteria along

with qualitative criteria such as the use ofexpert judgment of the submitter. Also a

disaster recovery plan should be part of

arrangement to account for human or

technological failures.

4. Conflicts of Interest: There is an inherent

Conflict of interest arising from the


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combination of roles of LIBOR setting and the

potential profits from trading positions in

instruments related to LIBOR, both internally

and externally. Contributing banks may, from

time to time, find themselves in a position

where other potential conflicts of interest

may arise. They should therefore remainvigilant in identifying new potential conflicts

arising from, for example, changes in the

business structure and/or responsibilities,

and in the development of new products.

Banks must thus establish and maintain a

clear policy delineating controls to manage

such conflicts and measures to limit an

individual from exercising inappropriate

influence over submissions. Submitters and

reviewers responsible for submissions should

treat any non-public LIBOR-related

information as sensitive and take appropriateprecautions to ensure the confidentiality of

such information.

5. Record keeping: Banks must store records of

its LIBOR submissions for a period of five

years and also document exposure of the

submitters to instruments which may be

affected by changes in the specified

benchmark. Records should also be

maintained for the process surrounding rate

determination and subsequent sign-off and

review along with all interactions between

submitters and internal/externaltraders/brokers.

6. Compliance and Audit: An independent

function must be setup for monitoring

compliance and reviewing banks internal

policies and procedures. Key functions of the

compliance would include advising

submitters on LIBOR setting activities,

reviewing reports, communication logs and

processes dealing with the LIBOR submission

process. The independent authority should

be equipped with resources and must have

the expertise to perform these roles without

interference and favor. A contributing bankshould also conduct periodic internal audits

of reasonable, random samples of its

submissions, the factors and all other

evidence documenting the basis for such

submissions and communications of the

submitters in order to verify the integrity and

reliability of the process for determining

submissions.

7. Reporting: Banks must appoint independent

auditor to verify and report to regulators on

compliance in this regard. Such an audit will

focus on the implementation of a frameworkdesigned to make LIBOR submissions

transparent and auditable.

Achieving ComplianceIn the light of the financial and reputational

impact of non-compliances, banks must

assess and prepare themselves for increased

regulatory environments in case of

benchmark rate submissions. The battle for

compliance has to be fought on multiple

fronts and would necessitate organizational,

operational and technological upgrades. Aneffective response must incorporate a

strategic and a tactical plan to gain an upper

hand and to ensure that zero financial and

reputational damage in the future and

enhance customer trust.


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Strategic Response-The traditional 3-Lines of Defence model

with clear demarcation between each line

must be reconfigured and armed to

effectively deal with the problem of rate

manipulation.

First Line: Business Line Management: To setthe compliance tone from top and establish

the required risk appetite, it is vital for the

management to have a robust oversight on

the LIBOR rate submission process. The Line

management should shoulder the

responsibility to identify and assess risks and

to ensure that the control activities and other

responses that treat risk are enforced and

monitored for compliance.

Second Line: Risk and Compliance function: It

is vital for the enterprise risk management

team to be entrusted with incorporating theneed to look at the processes governing the

benchmark rate determination and

submission process. They should act as

trusted partners to provide the element of an

outsiders view to the business functions

responsible for rates submission. They would

need to provide for a culture of compliance

and to design training courses for different

teams, set standards for risk management

and enforce structures. Undertaking regular

exercises to determine conformance with

regulationsThird Line: Internal Audit: The internal

auditors role is to provide objective and

independent assurance and consulting

services. They should assist the risk

management committees in reporting on

compliance, finding out issues and evaluating

existing processes and methodologies. This

entails audit of key controls, formal

reporting on the functioning of the LIBOR

submission framework and entity level

controls assurance.

Tactical Response-

A quick tactical response is also required toquickly establish a clear process and

methodology of submitting LIBOR rates. This

would mean implementing a solution that

provides a platform for different traders to

access a workflow that ensures compliance

and conforms to the new regulations. The

dashboard for LIBOR submitters would

contain real time market and trade data and

provides for audit and analysis.

The two key components of the strategic

solution would be

1. A mechanism for automated, controlledand scheduled capture of necessary

market data needed to both calculate

daily Libor rate. This would mean

establishing an interface with market

data providers such as Reuters and

Bloomberg and streaming that data

onto a dashboard accessible by front

office traders of different desks

2. The LIBOR Dashboard that provides a

simple web based interface that

collates current & historical data

required for the calculation of interbanking lending rate and provides a

workflow for review and submission of

the same. This will ensure transparent,

robust and auditable method of

submitting LIBOR rates with


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an approval workflow and appropriate

access/authorization controls.

The diagram below illustrates the

workflow the system will incorporate


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Conclusion The evolving regulatory

environment calls for augmenting and

implementing capabilities that can

orient risk and compliance functions

from detection to prevention. To

achieve this, exceptional business

intelligence and/or visual analytics toolsare necessary. There is a need to

empower the traders with tools that

reduce the time and cost of regulatory

compliance. Hence the right strategic

and tactical solution implementation

would go a long way in achieving

compliance and creating a robust

methodology for LIBOR rate submission.


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About the Author

Siddharth Mishra is a Consultant within the Cognizant Business Consulting (CBC) Practice. He has about eight

years of technology and consulting experience in the banking and financial sector and has worked with some of

the marquee names in the industry. Siddharth holds a post graduate diploma from S P Jain Institute of

Management, Singapore and has a bachelors degree in Engineering. He can be reached at

[email protected]

iFixed harmonyThe EconomistDec 7

th2013

http://www.economist.com/news/finance-and-economics/21591245-admission-collusion-exposes-banks-further-legal-woes-fixed-harmony

iiFCA Fines List- 2013 and 2014

http://www.fca.org.uk/firms/being-regulated/enforcement/fines/2013iii

The Libor SettlementsWall Street Journal

http://graphicsweb.wsj.com/documents/CAROUSEL2013/?slug=liboriv

LIBOR becomes a regulated activity

http://www.bbalibor.com/news/libor-becomes-a-regulated-activity

v LIBOR Code of Conduct

www.bbalibor.com/download/9070
mailto:[email protected]:[email protected]://www.economist.com/news/finance-and-economics/21591245-admission-collusion-exposes-banks-further-legal-woes-fixed-harmonyhttp://www.economist.com/news/finance-and-economics/21591245-admission-collusion-exposes-banks-further-legal-woes-fixed-harmonyhttp://www.fca.org.uk/firms/being-regulated/enforcement/fines/2013http://www.fca.org.uk/firms/being-regulated/enforcement/fines/2013http://graphicsweb.wsj.com/documents/CAROUSEL2013/http://www.bbalibor.com/news/libor-becomes-a-regulated-activityhttp://www.bbalibor.com/news/libor-becomes-a-regulated-activityhttp://www.bbalibor.com/download/9070http://www.bbalibor.com/download/9070http://www.bbalibor.com/download/9070http://www.bbalibor.com/news/libor-becomes-a-regulated-activityhttp://graphicsweb.wsj.com/documents/CAROUSEL2013/http://www.fca.org.uk/firms/being-regulated/enforcement/fines/2013http://www.economist.com/news/finance-and-economics/21591245-admission-collusion-exposes-banks-further-legal-woes-fixed-harmonymailto:[email protected]

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