In response to the recent LIBOR scandal, Michel Barnier, the European Commissioner for Internal Market and Services, has opened a consultation document on the continuing viability of the benchmark rate. The move is unsurprising to many observers of European financial markets, where multi-state collaboration is essential to the outcome’s perceived legitimacy. As mentioned in a previous post, U.S. CFTC Chairman Gary Gensler recently commented on the LIBOR’s future. The issue is undisputedly important, as rate manipulations may seriously impact market integrity, result in significant losses to consumers and investors, and distort the real economy. The consultation document, which will be open through November 15, follows an initial legislative proposal period, and sets the stage for the EU’s final response to widespread concerns regarding LIBOR. This post will discuss the now-completed proposal process, newly adopted amendments, and the European Commission’s response to persistent criticisms and concerns.
On July 25, 2012, the European Commission adopted amendments to the proposal for a Regulation and a Directive on insider dealing and market manipulation. The long-awaited initial legislative proposal to revise the Markets in Financial Instruments Directive (“MiFID”) was made on October 20, 2011. The original MiFID came into force in November 2007—intended to enhance investor protection, improve cross-border market access, and promote competition in the financial markets across the EU. Although MiFID has arguably achieved some of these aims, many commentators have suggested that the system ought to better reflect the lessons learned from the financial crisis and developments in the markets.
This aim may have been achieved with the newly adopted amendments that clearly prohibit the manipulation of benchmarks, including LIBOR and EURIBOR, and make such manipulation a criminal offense. However, changing the sanction regime alone may not be sufficient because it does not remove the risks of manipulation. To address these criticisms, on September 5, 2012, the European Commission opened up the above-mentioned “document,” requesting comments from stakeholders, contributors, providers and users on EU-wide regulation of financial indices.
This is a critical step. The Commission has observed that protecting the integrity of indices and benchmarks is crucial for pricing interest rate swaps and many other financial instruments because even allegations of manipulation can undermine market confidence. “Liborgate” highlights the risk of giving too much freedom to those who determine the indices. Beyond interest rates, a new LIBOR regulation regime should cover all the benchmarks, including price indices of raw materials and real estate.
The Commission has asked for comments on topics including, the scope, objectives and governance of these indices as well as the potential impact of regulation. Comparisons are made between the indices provided by private and public organizations. The report emphasizes the fact that “the integrity of indices is vulnerable whenever discretion is exercised,” and conversely, “[i]f an index is based on actual transaction or other verifiable data, the contributor of the data does not generally need to exercise discretion.”
When the consultations close on November 15, the Commission may decide to enact legislation. Currently, all options are on the table to restore the credibility of the indices—making the document’s open forum even more important. It appears unlikely that Europeans will entrust a public institution, such as the European Central Bank, with the calculation and validation of the failing indices. A more likely outcome includes regulating used data methodology and internal procedures to manage conflicts of interest among private interests producers.