Question for Short Debate
My Lords, during the three weeks or so since I entered the ballot for this slot, I have continued to maintain close contact with practitioners in the Libor market, as I support the case for a final resolution of the Tom Hayes case and press the argument to confirm the cancellation of his conviction. At present, he appears to be the only person alive in the world who has ever been convicted of a Libor offence. Everybody else has been acquitted and had their convictions cancelled. Indeed, in the USA, Libor manipulation is no longer regarded as a convictable offence.
Having continuous access to current opinions within the Libor community, I am beginning to consider that I am perhaps wrong in submitting my Question at present. There are too many uncertain factors surrounding this whole issue. First, there is no available market indicator as to the extent to which new Libor initiatives may have to be undertaken in the near future. It is too soon to ascertain whether any new initiatives will be required, arising from the present troubles in the world.
Yet these queries, however speculative and counteractive they may be to undertake, confuse the whole current Libor market. It is massively overstaffed at every level, and nobody knows who is supposed to be in charge on any initiatives. The market needs to be undone, taken apart and restored again, but not as a continuity of what we have. My principle, in seeking to wipe out what we have and start again, is a sensible proposal to run with, but we need to go back to basics.
For example, consider how very little we know of the actual incidence and effect of Libor for all or any portion of the near-80 years since its inception. Consider that we do not know how many Libor initiatives have been authorised or undertaken with official sanction, presumably, but not certainly, from the Bank of England. How many of these remain current, have been resolved or remain unresolved—that is, short-term funding not yet fully repaid? How many failed, and for how many were the rescue attempts successful? If we are to carry on in any form, we need a full and definitive report on what has happened in those 80 years and what we are left with.
I suspect that a good many did not work, and we have never been told their story. What indemnity arrangements remain in place to be utilised, not least to help those who allowed their funds to be used in a rescue and, presumably, have lost them? That is a great question to which we have never heard the answer.
If, at some point, an attempt is launched to terminate Libor, what effect would that have on existing unresolved cases? I am particularly concerned that we need to have an answer about what we will do for the future. A strange organisation called the Federal Reserve Bank of New York, which is not federal, not reserve, not New York and is not a bank—otherwise there is nothing wrong with it—is making a plea to the Federal Reserve, seeking the backing of the American Government to take over the entire Libor operation worldwide. We do not want anything to do with it. That is one reason why we might want to think of winding up now, so that we can take our own initiative, new and fully minted, with the Bank of England onside.
All these matters require close debate with the official bodies concerned, such as the Bank of England and the CSA. I now believe that my initiative in tabling this Question was premature for the reasons I have given. I request permission to withdraw it, but with the very strong recommendation that we now make separate approaches to the Bank of England and the CSA, and ask them to do their own assessment of the current status of the Libor market—its effectiveness and the extent to which there are unresolved issues out there in Libor initiatives which have been taken but are not yet resolved, of which I suspect there a good many, where funds are irrecoverable or have been misplaced. We need a definitive picture of what the Libor market looks like at this time. Let us not proceed to start the wind-up now, but let us get a definitive position on what the market shape and state is. I suspect it is in an awful mess.
I urge that exploratory initiatives are launched with the key bodies. We need an inside track on these matters so that we can redesign a Libor market which works for us. We also need to be sure if we do this that we are not cutting across unresolved issues, such as winding-up arrangements for banks which fail to survive the initiative, of which I suspect there are quite a few; that any mergers which were created as a wider solution are not interfered with; and that any banks that have been repaired can continue in good order without any interference. This is a very complicated situation, and we need a proper fix on what we have to deal with.
I thank noble Lords for allowing me to share my interest in these matters with them. I am very concerned by what I have seen in the five years of close association I have had in pursuing the Tom Hayes case—the only person to have been convicted in this country. He got 12 years; he served five and a half years. He now has multiple sclerosis and is in a very poor way indeed. We need a final resolution of his case, and I am sure we will. We have a date for the Criminal Cases Review Commission to review it in November and that will be very welcome.
I thank noble Lords for letting me speak to them today. This is the first time I have spoken on any subject since my brain haemorrhage in August. I know that anxieties were expressed as to whether the stress of talking to noble Lords might have any further implications, but I am feeling fine. There is an issue here. It must not be dropped. It is urgent. We need to attend to it. Please let us proceed and I will give any help to anybody who asks for it.
My Lords, I am very glad that the noble Lord’s health is supporting him through this debate. He is absolutely right to draw our attention to the importance of a liquid and well-functioning interbank lending market.
My understanding—and I will leave it to the Minister to make sure that we are properly informed and updated—is that Libor is no longer a valid benchmark, not only in the UK but now in the United States; that even the period in which synthetic Libor existed has now come to a close; and that the translation of outstanding contracts which had embedded in them the Libor benchmark to the new benchmarks has been overwhelmingly successful. I think we were all afraid that there might be some orphans left out there, where you could not contact one party or the other and therefore it was very difficult to make the legal changes necessary for the contracts to remain in place but attached to new benchmarks. My understanding is that that process has gone very well; I am sure the Minister will update us. Of course, in the UK now we have all migrated to the sterling overnight index average, known as SONIA.
That has been a successful process, but I want to pick up another point to which the noble Lord, Lord James, was directing us. I am not going to describe the mechanisms for Libor because everybody in this Room understands how that process worked. There was a panel of banks which submitted every day to the British Bankers’ Association their assessment of what it would cost them to borrow from other banks, in five major currencies and over lending periods of different durations. What concerned me, and I think many of us, was that that system, which relied on trust and was not transparent, was corrupted. For at least 10 years, the major players on those panels adapted their submissions to the British Bankers’ Association to suit their own target profitability, the bonuses of the traders who were informing the submissions to the benchmark and, frankly, the bonuses of senior management.
Not only was this extensive practice but it was completely open. When I was on the Parliamentary Commission on Banking Standards, we heard from quite a number of people about how, on the trading floors, a trader would shout quite openly, “I need a Libor submission set at this level because it will let me close this deal” or “so I get across my bonus benchmark”, or, “We need to do it as a favour to so-and-so at bank X”, or whatever else.
It was standard that Libor was a manipulated number and not a genuine estimate of what it would cost one bank to borrow from another, to the extent that in 2007 and 2008, when we had the financial crisis, the Bank of England, not for any purposes of self-reward but to try to stabilise the economy, contacted the chief executives of the major panel players as they made their Libor submissions and asked them to lowball the number to try to minimise panic in the market. This corruption and manipulation of the process was exposed by American journalists, who passed information to the US supervisors, who turned around and put pressure on the regulators in the UK, which led finally to an FCA report and essentially to the public acknowledgement that this system had completely failed to operate with integrity, probably for a period of at least 10 years.
I have a question for the Minister. We never bottomed out how great the impact of that manipulation was. To give noble Lords an idea of why I am concerned about that number, I have done a back-of-an-envelope calculation. According to figures provided to us by the Library, outstanding loans where the interest rate was based on Libor on any one day approximated $400 trillion. That is the daily outstanding block of loans for which Libor established the interest rate. That would have been a combination of variable-rate loans, which would have been Libor plus a spread, depending on the risk of the borrower—Libor plus 10 basis points, or perhaps 125 basis points for a riskier company—but also fixed-rate loans, because they were a Libor loan with a derivative with an interest rate swap sitting on top. Even fixed-rate loans attached themselves to the number established as the Libor benchmark.
If every day for a year—banks work in 360-day years—Libor manipulation increased the cost of borrowing by one basis point, the collective cost to borrowers would have been an overpricing of $40 billion on any one day. If that is extrapolated to every day for 10 years, we are talking about $144 trillion. This is without question the largest financial scandal ever. If one looks at those funds as being stolen, because the loans were deliberately improperly priced, we are talking about a scandal well in excess of all financial corruption of all kinds over the same period. We have never bottomed out that number. I wonder whether the Minister has a number that would give us an idea of what the theft from borrowers, which is what it was, amounted to.
The noble Lord, Lord James, is right that when the various regulators and enforcement authorities looked to hold someone accountable, they decided that our laws on fraud did not encompass misinforming or deliberately manipulating a benchmark. Therefore, almost nobody ended up paying any price for having participated in these schemes, nor did they lose the bonuses they had gained on the basis of the artificial profits that resulted from using them. As the noble Lord said, just one or two people ended up as scapegoats, usually for a fairly narrowly based conviction.
The damage done to London was extraordinary. London always relied on its reputation for integrity; “My word is my bond” was meant to be an underlying principle. It underpinned the whole notion of light-touch regulation and the beginning, in a sense, of the loss of our standing in financial services is very much linked to the whole Libor-era scandal. I am glad that Libor is behind us but incredibly sad that it happened this way. I understand that there have also been market changes that make things such as Libor less relevant, because there really was not enough depth in the interbank market to make the system—even if you operated it fairly and truthfully—particularly efficient. The move in our case to SONIA makes a great sense, for example, so I am glad that period is behind us.
However, as we look at legislation coming through Parliament that moves to much greater financial regulation, it is now important that we understand why Libor went so wrong, why regulators did not act and how weakened regulation could encourage a repeat of similar behaviour. When we get to the Financial Services and Markets Bill, I will particularly draw the Minister’s attention to the changes in the rules that are being introduced for black pools, which are basically exactly like the Libor panel clubs and in which people exchange information and carry out transactions. At present, those black pools are transparent because pre-trade transparency is a requirement under the European directives. That is about to be removed in the Financial Services and Markets Bill, which returns us to a construct like a Libor panel—one to be manipulated by major institutions.
I am extremely concerned that the lesson of transparency which the whole Libor scandal underpinned is now, in effect, being discarded as we move towards deregulation. Part of that is because we have never bottomed out the size of the damage done to borrowers, and it is about time that we had that number.
My Lords, I congratulate the noble Lord, Lord James of Blackheath, on securing this short debate and hope that he has not taken the shortness of today’s speakers’ list to heart.
As I understand it, the sterling Libor benchmark was wound up at the end of 2021. The Financial Conduct Authority continues to require the ICE Benchmark Administration to publish synthetic one-month, three-month and six-month sterling and yen rates. The yen rates will end this year, while the one-month and six-month sterling rates will likely cease at the end of March 2023. In its announcement of those dates, the FCA said it considered exposure to those sterling settings to be low. A limited number of US dollar rates will also be available until mid-2023, with those figures calculated using panel bank submissions rather than involving the IBA.
While the transition away from Libor affected a significant number of businesses, and continues to affect some, its phasing out was well trailed. Guidance was available from organisations including the Association of Corporate Treasurers, the Confederation of British Industry, the Institute of Chartered Accountants in England and Wales, and UK Finance. This helped many to prepare for the switching-off of the formal Libor rates last year. Various alternatives to Libor are now widely used, including the sterling overnight index average, SONIA, maintained by the Bank of England. SONIA is by no means a new measure, having been introduced back in 1997, but it has been subject to reform in recent years. The New York Federal Reserve maintains its own measure, the secured overnight financing rate, while several other rates are available to financial institutions and businesses. These alternatives are collectively known as risk-free rates and have been described by the Bank as “robust”.
Of course, not everyone has successfully transitioned away from Libor and some entities with so-called tough legacy contracts have found the process especially difficult. We had several debates on the Government’s approach to these contracts during the passage of the last financial services Bill. The subject was also covered by the critical benchmarks Bill, which sought to provide greater certainty around legacy contracts. However, with so much having happened in domestic and global economic terms since those Bills made it on to the statute book, can the Minister update us on any additional steps taken by the Treasury and regulators to assist those who were unable to transition on time? I am not sure how easy it is to pull all this data together, but I presume somebody has responsibility for it.
At present, unless I have missed a subsequent update from the FCA, no determination has been made on the winding-up of the three-month synthetic sterling rate. Firms’ exposure to that rate is felt to be higher than the one-month and six-month equivalents, raising the prospect that the synthetic rate may be provided beyond March 2023. This is, of course, a decision for the regulator and it will be for the IBA to follow any directions given to it. However, is the Minister able to provide any updates on the FCA’s deliberations? When is a final decision likely and how much notice will be provided? The FCA’s current advice for firms with contracts referencing the three-month measure is merely to prepare for its cessation “in due course”. Given the complexity of the challenges faced with these legacy contracts, I am not sure that is particularly useful.
The transition away from Libor appears to have been largely successful. I echo the comments of the noble Baroness, Lady Kramer; we were both somewhat pessimistic at the time of the original legislation, but it seems to have been largely successful. However, the work is not quite over. I hope the Minister can instil confidence that unresolved issues are indeed being addressed, as a risk to financial stability remains.
My Lords, I thank my noble friend Lord James of Blackheath for securing this debate. I too wish him well with his recovery. I am grateful to other noble Lords for their contributions. I recognise the work my noble friend has done to raise the profile of issues relating to Libor. However, it would of course be inappropriate for me to comment on any specific cases.
As we have heard, Libor is a benchmark which seeks to reflect the rate at which banks lend to each other in wholesale markets. It has been important historically not just for how our financial services industry operates but for mortgage holders, borrowers and lenders in households and businesses across the country and internationally. At its height, approximately $400 trillion of financial contracts referenced Libor. It was published in all major currencies, including the dollar, sterling, yen, the euro and the Swiss franc, and for various time periods. As noble Lords have described, in 2012, it emerged that Libor was being manipulated for financial gain, in what became known as the Libor scandal.
To digress slightly, I want to reiterate the point that this Government’s position on financial market abuse is clear: it undermines the integrity of public markets, reduces public confidence in them and impairs the effectiveness of financial markets. Therefore, those found guilty of such an offence should be held to account.
The noble Baroness, Lady Kramer, asked whether we had a figure for the overall impact of Libor manipulation. I do not believe that we do, but the seriousness with which we took this issue and the response by the regulators and law enforcement show that, even without such a figure, we appreciate the scale of what was implied by the scandal.
I am sure we will have much more detailed debates on these issues in the forthcoming Financial Services and Markets Bill but I reassure the noble Baroness that it is a question not of deregulating the markets but of improving the regulation and having regulation that is better tailored to the UK. We have the opportunity to look at what works in this country rather than across 27 different jurisdictions. That is the spirit in which the Government are taking forward that Bill. I hope that provides some reassurance.
Following the subsequent government-commissioned Wheatley review and the establishment of the Parliamentary Commission on Banking Standards, Libor came under the regulatory jurisdiction of the FCA in 2013. This led to significant improvements to the regulation and governance of Libor. However, following the 2008 financial crisis, the ways in which banks raised short-term capital changed fundamentally. In particular, banks increasingly moved away from borrowing from other banks to fulfil funding needs. As a result, the unsecured interbank lending market, which Libor seeks to measure, became increasingly shallow.
Furthermore, in light of fundamental changes to bank capital-raising, in 2014 the G20’s Financial Stability Board declared that the continued use of Libor represented a
“serious source of … systemic risk”
and encouraged national authorities and financial institutions to move to alternative rates. In line with this transition plan, in 2017 the FCA announced that Libor would be published only until the end of 2021. Since then, the Government, the FCA and the Bank of England have worked together to support a market-led transition away from Libor.
As noble Lords in this Room will know, because the two noble Lords opposite me were here for the passage of the Financial Services Act 2021 and, unlike me, for the Critical Benchmarks (References and Administrators’ Liability) Act 2021, these gave the FCA the power to compel the production of synthetic Libor rates. I note that on the basis of the framework the wind-down of Libor is progressing well. Synthetic Libor provides for continuity of a Libor setting for up to 10 years. This is for the benefit of the contracts which have proved very difficult to transition—the tough legacy contracts; in other words, it is a safety net for tough legacy contracts.
The noble Baroness, Lady Kramer, said that synthetic Libor is no longer available. That is not quite correct. Since the end of 2021, we have seen a greater than anticipated reduction in the overall stock of Libor-referencing contracts, but synthetic Libor remains available where it is needed. The noble Lord, Lord Tunnicliffe, asked about additional steps the Treasury and regulators have taken to assist those who are unable to transition in time. The synthetic Libor rates for certain sterling and yen settings are there for the benefit of those who were unable to transition. The FCA will consider the data on remaining exposures when taking decisions on how long to continue its rates.
The noble Lord asked specifically about when a final decision on the winding-up of the synthetic three-month sterling Libor rate will be taken and how much notice will be provided. Over the summer the FCA published consultations on the future of the remaining Libor rates. In line with its requirement to consult on its decisions relating to synthetic Libor, the FCA will respond to the consultations in due course, but it understands and factors in the need to ensure that adequate notice is provided.
The synthetic rates for sterling and yen Libor seek to replicate as far as possible the economic outcomes that would have been achieved under Libor’s panel bank methodology. The FCA selected a methodology in line with the global consensus of firms and regulators, including extensive domestic consultation.
As many noble Lords will know, the synthetic sterling rate is calculated using the Bank of England’s sterling overnight index average—SONIA—which is administered by the Bank of England and, importantly, is based on approximately £60 billion worth of actual transactions of the interest rates that banks pay tomorrow, sterling overnight from other financial institutions and institutional investors each day. This means that SONIA is far more robust and resilient to any risks of manipulation, such as those seen before 2012. By imposing a synthetic methodology based on SONIA, the FCA can provide more time for certain legacy contracts to move to alternative benchmarks, thus reducing the risk of disruption.
The Libor benchmark has been globally important for many years, not just for those who work in financial services but for people across the country and around the globe. But, given the fundamental changes in global finance in the past 20 years, it has been appropriate to transition away from Libor safely and predictably. The UK is the home of Libor and has taken action to support the global, market-led transition away from it, reaffirming our commitment to being a trusted custodian of a global financial services sector.
The work of the UK authorities to encourage the transition away from Libor has been highly successful so far. For instance, of the estimated £30 trillion of sterling Libor exposures outstanding at the beginning of 2021, estimates show that less than 1% now remain on synthetic sterling Libor. I hope that that goes some way to answering the noble Lord’s question about the estimated number of unresolved cases. If we had not played the role that we did, the disorderly cessation of Libor could have presented a significant global financial stability risk because of the vast number and variety of contracts that reference it.
My noble friend Lord James asked what steps the Government are taking to ensure that the Libor system remains available. I hope that I have been clear about why the Government have taken the action they have to ensure a smooth and orderly wind-down of Libor. The Government continue to encourage transition away from Libor to more robust risk-free rates, such as the Bank of England’s SONIA. The Question also referred to the risk of the collapse of interbank lending. The interbank lending market that Libor seeks to measure is of course just one way that banks can fund themselves. Banks have a range of possible sources of funding available to them, including savers’ retail deposits and investors’ wholesale funding, as well as the banks’ capital base. As I said, the way in which banks fund themselves has fundamentally changed since 2008.
Of course, the other thing that has changed since 2008 is that the banking sector is substantially more resilient than before the financial crisis, with higher levels of capital and liquidity. This is because of reforms introduced after the financial crisis that require banks to hold more capital and reduce their reliance on short-term funding, such as interbank lending. For example, banks are now required to hold enough liquid assets to meet their projected outflows for at least the next 30 days, and to have enough funding with a maturity of greater than a year to fund their assets.
In addition, I reassure noble Lords that the Bank of England has a range of tools and facilities that can be called upon to support bank liquidity in the event of market stress, including liquidity insurance facilities, which are used to ensure that it achieves its financial stability objectives. These facilities can be called upon if banks stop lending to each other in the event of market stress.
To conclude, overall, the reforms introduced since 2008 have increased the financial stability of the system and will prevent the costs of banks failing from falling upon taxpayers. The sensible management of the wind-down of Libor is vital not only to the integrity of the UK’s markets but to the UK’s credibility internationally. We have worked closely with international partners in the approach that we have taken, and we received praise from them for that. The Government will continue to engage with regulators to ensure a smooth ultimate end to this transition and, in doing so, underline the UK’s reputation as a well-regulated and effective global financial centre.