UK: The Wheatley Review of LIBOR

Today the Wheatley Review of LIBOR published its final report.

Recent revelations have demonstrated that the current system of LIBOR is broken and needs a complete overhaul. It is clear that wholesale reform is required to restore credibility in the benchmark.

The Wheatley Review sets out a clear a 10-point plan for reform, which includes:

• new and robust regulation;
• a fundamental overhaul of the way LIBOR is run, including taking responsibility away from the BBA;
• a requirement for banks to back up their submissions with evidence of relevant transactions; and
• detailed technical changes to refine the way LIBOR is put together, to make it much harder to manipulate.

Mr. Wheatley said:

“Trust in a vital part of the financial system has been badly damaged. Today’s report sets out my plans for reforming what has become a broken system and to help restore the trust that has been lost. LIBOR needs to get back to doing what it is supposed to do, rather than what unscrupulous traders and individuals in banks wanted it to do.

“I have concluded that LIBOR can be rehabilitated through a comprehensive and far-reaching programme of reform.  Although the current system is broken, it is not beyond repair, and it is up to regulators and market participants to work together towards a lasting and sustainable solution”

Financial Secretary to the Treasury, Greg Clark, said:

“Today’s independent report is very clear – the self-regulation of LIBOR has failed. It’s yet another example of the broken regulatory system that this Government is committed to fixing.

“LIBOR is a hugely important international benchmark and this report makes a series of comprehensive and practical recommendations designed to restore its credibility. The Government will respond, in full, once Parliament returns.”

Speech by Martin Wheatley 'Pushing the reset button on LIBOR', 28 September 2012

FSA: Pushing the reset button on LIBOR

Speech by Martin Wheatley - Managing Director, FSA, and CEO Designate, FCA at the Wheatley Review of LIBOR

Good morning and thank you all for coming today.

Firstly I want to thank the Financial Secretary for his introduction.  I also want to thank the Lord Mayor for allowing us to host this morning’s event here in the heart of the City of London, a place built on a strong foundation of confidence and trust.

Confidence and trust are critical to financial markets.  Whether it is something common-place like opening bank accounts or something as previously obscure as the London Interbank Offered Rate, or LIBOR.  We need finance to work well – for consumers from all walks of life.

The reason we are here, however, is that we have been misled.   The system is broken and needs a complete overhaul.  The disturbing events we have uncovered in the manipulation of LIBOR have severely damaged our confidence and our trust – it has torn the very fabric that our financial system is built on.

Today we press the reset button; we need to:

• get back to what this reference rate is supposed to do;
• restore integrity to a globally important benchmark; and
• make sure we get to a position where individuals act with integrity.

This is not a London issue.  This is a global issue and is why I have been working in partnership with my counterparts in the US, Japan, Switzerland, the EU and elsewhere.  

For my part, when the Chancellor of the Exchequer asked me to carry out this review on behalf of the UK government; I was clear about the absolute importance, scale and challenge of this task.   The shocking behaviour exposed by the FSA and others demonstrated that an independent review of LIBOR was needed.

We have carried out that work, with a thorough and considered look at what went wrong and what should be done to put things right.

But pressing reset is not as simple as pushing a button. Today I am publishing a 10-point plan for extensive and lasting reform of a broken system to restore the trust that has been lost.  LIBOR needs to get back to doing what it is supposed to do, rather than what unscrupulous traders and individuals in banks wanted it to do.

First and foremost, I have concluded that LIBOR can be fixed through a comprehensive and far-reaching programme of reform.  Although the current system is broken, it is not beyond repair, and it is up to us – regulators and market participants – to work together towards a lasting and sustainable solution.

LIBOR is used in a vast number of financial transactions; with a value of at least $300 trillion.  The deep entrenchment of LIBOR as a reference rate in financial markets, and the subsequent effect on those markets in the event of a disruption to the rate, mean that any case for replacement entirely would have to prove that LIBOR is:

• beyond repair;
• that a better alternative existed at this moment in time;
• and critically, that an immediate and smooth transition to that alternative could be made.

I have concluded that none of these conditions have been met and that instead there is a clear case for comprehensively reforming LIBOR, rather than replacing it.

Secondly, I have concluded that LIBOR submissions should be supported by relevant trade data and proper record keeping.

Some degree of judgement will have to be retained, because even in the more liquid markets there is not enough daily data available to have a system in place that is entirely based on market transactions, particularly in times of stress.

But we can’t allow the unfettered latitude that banks enjoyed previously. Much greater rigour and transparency must be introduced to the process of submission. Let me return to this point later.

And third, we must remember that LIBOR is a creation of the market, invented by the market for the market. It is clear that proper regulation and sanctions are needed and we stand ready to provide that, should the government agree. But banks and market participants must play their part too.

My recommendations combine both long-term and immediate changes, which I will explain in detail.

The three broad areas that these recommendations cover are:

1. Regulation - Introducing a new regulatory structure for LIBOR, including criminal sanctions for those who attempt to manipulate it.
2. Governance – Transferring the oversight and governance role from the British Bankers’ Association.
3. The rate itself - A range of technical changes to make the system work better, including streamlining a lot of the currencies and maturities currently used.

Today we begin to put this right.  This responsibility will be taken forward by the new Financial Conduct Authority – which I will lead – and which will focus on making sure that financial services and markets function well, by promoting market integrity, consumer protection and effective competition.

Ensuring that the UK financial services sector conducts its business in line with the highest standards of integrity is vital work.

Consumers and market participants must be sure that the regulators stand ready to deal quickly and effectively with issues as they arise – our work on LIBOR over the last seven weeks is testament to this new approach.

There are three things I want to cover today:

• why LIBOR is so important;
• what went wrong; and
• what is needed to restore confidence in LIBOR.

So, first, why is LIBOR so important?

Since the scandal came to light, we have all become aware of LIBOR, once an obscure benchmark, and its importance as an integral part of the modern financial system.

What struck me when the manipulation was made public was how much it angered people – they were rightly upset that something so important was so badly run, had such poor governance, and was manipulated without regard to the consequences.   It said something about the culture of financial services, but also led people to question what they can rely on.

As I have mentioned, LIBOR is used as a reference price for well over $300 trillion worth of loans and transactions around the world.  These range from interest rate swaps to direct lending and the pricing of mortgages to ordinary people, as well as commercial loans to businesses.

The Economist calls LIBOR the most important figure in finance, and they are not wrong. In simple terms – it represents the cost of borrowing to banks.  How much a bank has to pay to borrow money is a key determinant of the interest it will charge to lend money. It is therefore vital that people can trust it.    And that is why it is critical that it works well and my recommended reforms are deep, wide and effective to ensure that the trust and integrity of LIBOR is fully restored, and quickly.

So that’s why it matters – now what went wrong?

I would like to step back for a moment and briefly explain exactly what went wrong with LIBOR – I will then link each of my recommendations back to these failings.

There were fundamental flaws in the current system.  These were the deep failures in the way LIBOR submissions are made, how LIBOR was governed, and the way it was policed.

Submissions

The key flaw was the inability in the system to manage conflicts of interest.  The rate is meant to represent the true cost of borrowing to a bank.  Two problems occurred.   First, any complex bank has a myriad of different deals, particularly in the swaps market – which became more or less profitable depending on the rate of LIBOR.  Traders whose bonuses depended on these deals had an interest in pushing LIBOR up or down, depending on the deal.  They were allowed to do this freely with no oversight.

The second problem was that, at the height of the crisis in 2008, nobody knew which banks were safe.  The price a bank had to pay to borrow from another bank was an indicator of what banks thought of each other.  Nobody wanted to be at the top of that list so, again, there was an incentive to lie and put in a lower figure.  This was made more complex by the fact that at the time, banks effectively stopped lending to each other.  So there were very few actual trades to inform the decision.

Banks were further encouraged to make it look like their borrowing costs were lower than they actually were because the transparency in the system contained a fatal flaw: banks’ individual submissions were published immediately. This gave an instant indication of their creditworthiness.

What’s more – and worse – is that we are not talking about a few rogue individuals here, but a systemic problem. In the case of Barclays, for example, there was a web of traders that worked together to try and manipulate LIBOR to benefit one another.

To sum up, the system had in-built conflicts of interest from the start – banks could submit what they wanted – and with traders’ bonuses dependent on the LIBOR rate, and no bank wanting to be seen as vulnerable in such a transparent system, too many people had a vested interest in gaming the system.

Lack of oversight

The second fundamental flaw was a lack of oversight.

As we all know the British Bankers’ Association is currently responsible for the day-to-day running of LIBOR.  Oversight of LIBOR is the responsibility of a committee set up by the BBA with two subcommittees looking at unresolved problems and disciplinary procedures respectively.   The only problem is that these committees hardly ever met.

This is symptomatic of a careless approach that did not place enough emphasis on the importance of LIBOR from both a governance and regulatory perspective – essentially, people had an overt level of trust in a system that did not have the right level of checks and balances in place.  

And the contributing banks themselves?  What did they do?  One bank we know of made no effort at all to aid credible submissions and has now paid the price.   Other banks will follow.

Organisations and individuals were basically left unchecked and were free to act without scrutiny, leading to abuse of the system – they essentially exploited the lack of checks and balances.  This is not good enough – just because the system provided that opportunity, society does not expect institutions with proud histories and millions of customers around the world to take advantage of it.

It is clear to me that, while the system lacked the right level of oversight, contributing banks also need to stand up and take responsibility for the quality of the submissions they make to the LIBOR process.

Lack of external accountability

Let me turn to the final flaw in the current system - the lack of external accountability.

Under the current regulatory and legal framework, the FSA does not regulate the process of making or compiling Libor submissions. While the FSA is currently taking regulatory action in relation to attempted manipulation of LIBOR, this is on the basis of the connection between LIBOR submitting and other regulated activities.

Further, because of this, individual employees of banks involved in the process do not have to be approved by the FSA.  This restricts the regulator’s ability to take disciplinary action against individuals.

In hindsight, it now appears untenable for such an important process to be unregulated.

So this is the final lesson. There is a clear lack of external accountability to safeguard that the incentives of those involved in this process are aligned with the wider interests of market participants, benchmark users and the public.  Added to this, there is a lack of a comprehensive sanctions regime to ensure that those who manipulated the rate are brought to book.

Overall then, the evidence we have seen in relation to this manipulation paints a clear and damning picture about the prevalence of the wrong incentives, and the sorts of behaviour that has allowed.

Whilst conduct in the banking industry at large is rightly a separate and ongoing debate, which is being taken forward by Andrew Tyrie's committee on banking standards, my mandate is clear. Reform is needed to prevent the possibility of this gross misconduct from reoccurring – both in how LIBOR is constructed, and how it is overseen and enforced.

My team and I have addressed each of these failings in the recommendations that I will set out for you now.

The Wheatley Review recommendations

Consultation

Following the launch of my Discussion Paper on 10 August, we have met with a large number of stakeholders, and considered the many written responses that we received.

I would like to offer my thanks to all those involved for their timely and thought-provoking engagement with the Review.

Having considered all the issues and evidence in detail, let me turn to the steps that should be taken to ensure that LIBOR becomes a relevant, valued and trusted benchmark.

The report sets out a comprehensive 10-point-plan to fix LIBOR.  This is through reforms to put a stop to what is a broken system built on flawed incentives, incompetence and the pursuit of narrow interests that are to the detriment of markets, investors and ordinary people.

Regulation of LIBOR

The first step for credibly reforming LIBOR is to ensure that there is a clear, consistent and effective regulatory regime that underpins all activity.

This would allow the FSA to take action against those who break the rules, and provide confidence that misconduct will not be left unseen or unpunished.

In the light of recent evidence, it is clear that better and stronger regulatory tools are needed to crack down on such unacceptable behaviour.

I am recommending three specific regulatory changes to achieve these goals:

• first, submission and administration of LIBOR should become regulated by the FSA;
• second, the key individuals in these processes should be FSA approved persons; and,
• finally, the government should amend the Financial  Services and Markets Act to allow the FSA to prosecute manipulation or attempted manipulation of LIBOR.

Bringing the submission and administration of LIBOR under the FSA’s regulatory umbrella will enhance the FSA’s ability to:

• put in place rules that set out requirements on firms to ensure the integrity of the submission process;
• allow the FSA to supervise the conduct of firms and individuals involved in the process; and
• critically, the FSA will be able to take regulatory action against firms and approved persons in relation to misconduct, including public censure and financial penalties.

Many of the problems we have seen are down to the behaviour of individuals.  These powers will allow the FSA to approve key individuals for these roles, ensuring that they are fit and proper to perform the job, something which is clearly lacking in the present system.

As part of this process, my final recommendation is to amend the Financial Services and Markets Act to include, as an offence, the making of a false or misleading statement in order to manipulate LIBOR.  This would enable the FSA to use criminal powers for the worst cases of attempted manipulation.

These powers to take action against wrongdoers will be in addition to the powers under the new European market abuse regime.  The European Commission has acted quickly to amend this new regime so that it will apply to manipulation of benchmarks.

The UK government should continue to assist in finalising the new Market Abuse Regulation, which will apply across Europe, and bring another level of protection against manipulation.

Institutional reform

But statutory regulation – while vitally important in providing assurance and confidence in the process – is not a panacea.

Whilst the changes to the regulatory regime I have outlined will provide a sizeable and robust foundation for reform, it is equally important that the governance and oversight of LIBOR is overhauled.

To achieve this I recommend that:

The British Bankers’ Association clearly failed to properly oversee the LIBOR-setting process and should take no further role in the administration and governance of LIBOR.  Responsibility should be transferred to a new administrator.  We are today starting an open tender process to invite organisations to take over the running of LIBOR.  I am confident that there are a number who are willing to take it on and meet my expectations regarding the new institutional model of governance and oversight, which I have set out in detail in my report.

The process of transition to a new body is crucial; and it must be open, transparent and efficient, to ensure fairness and minimum disruption and volatility in markets. We must also ensure that the process delivers on restoring trust in the running of LIBOR.

As I have recommended in my report, there should be a tender process to be run by an independent committee convened by the regulatory authorities.

I am very pleased to be able to announce that Baroness Hogg, chairman of the Financial Reporting Council, has agreed in principle to chair this panel once it is established. Sarah brings an unparalleled depth and breadth of experience in corporate governance, regulation, public policy and financial services to this crucial task, and I can’t think of anyone better placed to lead it. I am delighted she has agreed to take this on.

The new administrator should fulfil specific obligations such as surveillance and scrutiny of submissions as part of its governance and oversight of the rate.

Broadly, I expect that new institutions should demonstrate much greater independence, with a clear distance between institutions and submitting banks. A specific oversight process also needs to be set up at administration, governance and bank levels. There must also be transparent systems, processes and structures, with clear accountabilities at every level.

It is essential that the conduct of the new administrator should be rigorous and transparent, in order that they cleanse the brand of LIBOR, and generate trust in the process moving forward.

The rules for governing LIBOR

Earlier I outlined the need to retain some level of judgement. But judgement needs to be explicitly and transparently linked to trade data wherever possible.

A number of my recommendations are therefore intended to establish strict and detailed processes for verifying submissions against hard data.

I expect that the first priority of the new administrator should be to introduce a code of conduct for submitters. This code of conduct should introduce specific guidelines prescribing that submissions be corroborated by trade data.

Submitting firms will be subject to new tough systems and controls that will be put in place. Transactions will need to be recorded and there needs to be a requirement for regular external audit of submitting firms.

The market also needs to know whether a submission has been made based on transactions or not.

Only with such rules and guidance can we ensure that the process has the much needed integrity.

Once the regulatory regime which I have described is up and running, this code of conduct should become industry-led and regulator-approved guidance.

Until this tender process has concluded, submitting banks should move to compliance with the submission guidelines presented in this report.

Immediate improvements to LIBOR

The recommendations that I have set out so far, are designed to generate extensive and lasting reform.

But a comprehensive approach to reforming LIBOR inevitably requires changes to be made immediately.   LIBOR as a reference rate continues to function as we speak. So what changes should be made now, to strengthen the rate as quickly as possible?

My report sets out a number of recommendations for immediate changes to the way in which LIBOR is derived, designed to establish a link between transactions and submissions, something advocated by many stakeholders as a way of enhancing credibility.

We examined the volume of transactions underpinning each LIBOR benchmark and the variance across different maturities and currencies.   Some of these contained very few trades and some LIBOR benchmarks are used for very few transactions.

I therefore recommend that the BBA, and in due course the new administrator, should remove those currencies and tenors from LIBOR, which lack a sufficient amount of trade data to corroborate submissions – we aim to phase out these rates over the next 12 months or sooner, where possible.

In particular, Australian, Canadian and New Zealand dollars, as well as Swedish krona and Danish krone, will be phased out. We also aim to reduce the maturities published by removing some of the intermediate tenors, such as four, five, seven, eight, ten and eleven months. This emphasis on the liquid segments of the market will further strengthen the link between submissions and observable transactions.   This will reduce the current number of LIBOR reference rates down from 150 to a number where we are confident there is a real market to underpin the rates.

As I explained, the publication of individual submissions by banks - a measure that was originally intended to enhance transparency - has paradoxically facilitated manipulation.  These details will remain available to the oversight committee, administrator, and the FSA for the purpose of oversight and scrutiny. I appreciate that this may be seen as a slight reduction in immediate transparency, but to rectify this, we have recommended the regular publication of a statistical bulletin, including trading volumes and values for the inter-bank funding market.

I am recommending that publication of individual submission is delayed by at least three months on a rolling basis, with the information remaining available to the oversight committee, the new rate administrator, and the FSA.

It is clear that there is a large gap between the number of banks which submit to the LIBOR process, and the number who use LIBOR as a reference rate, which has created a free rider problem. This is an issue which I consider should be quickly resolved.

Not only would an increased number of submissions help inform the LIBOR rate, which is supposed to represent the market as a whole, it would also discourage manipulation.

Subsequently I am recommending that relevant banks who do not currently submit, should be encouraged to participate as widely as possible in the LIBOR compilation process, including, if necessary, through new powers of regulatory compulsion.  LIBOR requires collective responsibility if it is to work effectively.

Finally, market participants should be encouraged to consider and examine their present use of LIBOR as a reference rate. Is it the most appropriate reference rate for transactions that they undertake? Or are the other benchmark rates that are more appropriate?

Alternatives for LIBOR in the longer term

My report also considers the viability of alternatives to LIBOR in the longer term. Specifically, if there is a case for an environment where a variety of viable alternatives to LIBOR could exist simultaneously.

It also analyses the case for involvement of the authorities in any move towards either a replacement to LIBOR, or a plurality of alternatives. And finally, it sets out the most plausible candidate alternative benchmarks that were presented in my Discussion Paper, and examining each in more detail.

However, it is clear that there is widespread debate ongoing in the international community concerning the appropriate role of authorities around the globe in regard to a variety of benchmark rates. And several international organisations will be examining and recommending approaches to these issues.

I recommend in my report that international authorities should take forward a discussion of existing applications of interbank rates such as LIBOR, the merits of alternative reference rates for certain applications, and the role – if any – that the authorities should play in facilitating transition to these reference rates for future contracts.

In the first instance I believe that this discussion should be guided and coordinated by the Financial Stability Board (FSB), working in conjunction with International Organization of Securities Commissions (IOSCO), the European Commission and other interested international institutions such as the Bank of International Settlements.

Implications for other benchmarks

While today is about LIBOR, it is of course only one of a number of important benchmarks that are used in contracts around the world. And some commentators have already put the spotlight on other major international benchmarks, for example there has already been a substantial amount of work on Price Reporting Agencies in the oil market, led by IOSCO.

Further, there are a large number of other important benchmarks in other commodity markets – for example for the prices of agricultural products and precious metals – and in the equity, bond and money markets, which have not yet been reassessed, but which may need to be looked at given the current scrutiny of benchmarks.

Whilst other benchmarks vary greatly in design and application, I hope that those responsible for them will be able to draw some important lessons from my report on LIBOR, and that it will help stimulate wider debate on benchmarks.

In particular, I consider that it should be possible to develop a set of overarching principles that can be applied to all major benchmarks, to promote robustness and credibility across the markets.  In my report I have set out some basic features that, in my view, any major benchmark should have.

Many of these benchmarks are compiled in different parts of the world, and many are applied to contracts all over the world, so naturally I would expect that any such work is coordinated at the international level. My report outlines the various pieces of work that are already underway in different parts of the world.

As many of you will know, Gary Gensler, Chairman of the Commodity Futures Trading Commission, and I will co-chair an IOSCO task force.  We believe this task force will provide a useful vehicle to help advance this important work. Crucially, this IOSCO task force will be informed by the European Commission’s work on Regulation of Indices, as well as IOSCO’s Principles for Oil Price Reporting Agencies.

The European Commission has launched another important strand of work on the use and possible regulation of major benchmarks in Europe.

It is only through team work and collaboration that the various authorities and bodies will develop effective and lasting solutions to these issues.

I look forward to working with Chairman Gensler on this crucial aspect of international work; as well as with other international institutions such as the Financial Stability Board and key European institutions.

Domestically, my report also considers some examples of other important benchmarks that are UK-related and recommends that further work be taken forward by the UK authorities with respect to benchmarks that are compiled in the UK or relate to sterling products.

Concluding remarks

In closing, I would like to reflect on the range of issues covered today.

The evidence backs a strong case for reforming LIBOR.

Governance of LIBOR has completely failed resulting in the sort of shameful behaviour that we have seen.  This problem has been exacerbated by a lack of regulation and a comprehensive mechanism to punish those who manipulate the system.

That is why I am recommending that the FSA is given clear and extensive powers to ensure that regulation is able to cover the offences, and that there is enough clout to punish those who break the law.

But this regulatory foundation must serve as the last line of defence, behind an overhauled governance structure, with a new, independent body, backed by a clear code of conduct, with clear rules and procedures regarding submission.

These changes will ensure that the market can once again have confidence in LIBOR going forward, and that the public both in Britain and abroad, are reassured that this problem will not happen again.

There is still much work to be done on an international level in regard to the appropriate use of benchmarks in all markets, and the appropriate rules and regulations that should be applied. I encourage those bodies to consider and respond to this report.

Together, we need to get this right so that people and businesses can depend on a system that works, with good regulatory oversight, governance and reliable information.  I submit this review to the government for its consideration, and look forward to their response in due course.

Thank you.

Mauritius International Arbitration Conference 2012 - An African Seat for the 21st Century

The second biennial Mauritius International Arbitration Conference marks the successful continuation of the dynamic project, launched in 2010 by the Government of Mauritius and leading arbitral institutions, to create a new platform in the region for international commercial and investment arbitration. As part of this project, Mauritius:

• adopted state-of-the art legislation based on the UNCITRAL Model Law, adapted to best serve the interests of international users (November 2008);
• concluded a Host Country Agreement with the Permanent Court of Arbitration (PCA) at The Hague pursuant to which the PCA appointed to Mauritius its first overseas representative (April 2009);
• hosted the inaugural Mauritius International Arbitration Conference in December 2010;
• has cooperated with the LCIA to open a dedicated and state-of-the-art Centre for International Arbitration; and
• successfully bid to host the 2016 Congress of the International Council for Commercial Arbitration (June 2012).

This conference will be opened by the Prime Minister of Mauritius, with a keynote address by the Head of the Office of Legal Affairs of the United Nations. It will feature panels formed of international and regional leaders in the field, and will see Mauritius continue to establish itself as a centre of expertise and training in international arbitration for the African continent and beyond.

From the unique perspective offered by Mauritius as a natural gateway into Africa, panels under the chairmanship of the heads of the co-hosting institutions will consider current and emerging issues in international arbitration under the theme An African Seat for the 21st Century. Specifically, over two days:

• Three panels on international commercial arbitration, chaired by the President of the ICC Court, the Director General of the LCIA and a senior member of the ICCA Council will engage in a critical examination of various aspects of the role of the courts: in giving effect to arbitration agreements; in supporting arbitral proceedings, and in the recognition and enforcement of awards. A speaker on each panel will provide an African perspective on each topic.
• Three panels on investment arbitration, chaired by the Secretary of UNCITRAL, Secretary-General of ICSID, the Secretary-General of the Permanent Court of Arbitration, will aim to provide a fresh perspective on: arbitrator appointments and challenges, sovereign debt issues in investment treaty arbitration, and the management of regulatory risk.

Mauritius: Workshop Explores Business Opportunities in Mozambique

Trade and Investment Opportunities in Mozambique was the focus of a half-day informative and interactive workshop which was held this morning in the Lunch Room of the National Assembly in Port Louis at the initiative of the Ministry of Foreign Affairs, Regional Integration and International Trade.

The objective was to develop the right synergies to increase trade and investment in the Maputo corridor.  This initiative is in line with Government’s policy of mapping out a coherent plan of action in order to further develop Mauritius’ relations with Africa, especially with Mozambique with which Mauritius shares ancestral ties.

The workshop brought together more than sixty participants from the public and private sectors and the business community.  They were apprised of existing opportunities in Mozambique and were given an overview of the major sectors in which the potential for investment exists namely agriculture, fisheries, transport, building and construction.

In his opening address the Secretary for Foreign Affairs (SFA), Mr A. P. Neewoor, recalled that the African continent is now regarded as the last and new frontier for business opportunities in the world.  It has proven that it can deliver with a growth rate exceeding that of many countries including those in Europe and Asia.  Therefore opportunities are boundless to invest on that continent, he said.

According to the SFA, Mozambique stands out in respect of investment opportunities because of both the availability of resources and its shared privileged relations with Mauritius.  He pointed out that Mauritius wants to add substance to these ties.  The Government as facilitator is hopeful that full advantage will be taken to see whether the business community can be part of the process to bring about economic transformation not only on the African continent as a whole but in particular Mozambique, he added.

For his part, the High Commissioner of Mauritius to Mozambique, Mr J. H. Lamvohee, pointed out that historical ties between the two countries and strong bilateral relations provide the ideal basis and platform to act as a gateway for the private sector of Mauritius to take advantage of the opportunities that exist in Mozambique which has a growing and stable economy.

Mozambique can be used as a production base to supply the region and Europe and elsewhere but it also represents a unique market opportunity in some niche areas in which Mauritius has a cutting edge, he said. 

Mauritius and Mozambique share strong and privileged relations.  Both countries have a number of instruments in place including a Double Taxation Avoidance Agreement, an Investment Promotion and Protection Agreement, a General Framework Agreement of Bilateral Cooperation, a Memorandum of Understanding (MOU) on Cooperation in Fisheries and an MOU on Cooperation in Food Security.  The two countries also share common membership of the SADC, ACP Group and the African Union.

Mozambique has emerged from decades of armed conflict to become one of Africa’s best-performing economies.  The country has a growth rate of more than 7% presently and in the last three to four years has had a sustained growth rate of 7 to 8 percent.

FSA - Strengthening Defences: Tackling Financial Crime from the Regulator’s Perspective

Speech by Tracey McDermott, director of the Enforcement and Financial Crime Division at the 10th Annual British Bankers’ Association (BBA) Financial Crime Conference

Good morning ladies and gentlemen. Thank you to the BBA for inviting me to speak at its tenth financial crime conference. 

The timing of this event is appropriate.  The last few months have once again seen a host of financial crime related issues from anti-money laundering (AML) controls, to insider dealing to boiler rooms to good old fashioned fraud hitting the headlines.  These scandals damage yet further the reputation of the industry.  More importantly, each of them causes damage to individual victims, the market and to the economy as a whole.  They emphasise once again the critical importance of tackling financial crime in all its forms.

Today I will focus on the role the FSA – and subsequently the Financial Conduct Authority (FCA) – as regulator, plays in this.  But this is not a job for the regulator alone.  To be effective in this area, we must, as I mention below, work with other agencies.  And, just as importantly, the industry must play its part in rooting out fraud and showing zero tolerance to those within the industry who tarnish its name by failing to meet basic standards of honesty, integrity or competence.

The issue of financial crime will certainly not be going away.

The Financial Conduct Authority

As you know, the regulatory reform process is well under way.  This is the last speech I will give to you presenting the Financial Services Authority's views on financial crime. The Financial Conduct Authority, or FCA, is in the wings waiting to take over. And I believe this new organisation will be well placed to take a robust stance on financial crime.

The Bill currently going though Parliament gives a very clear mandate to the FCA in relation to financial crime.  Its integrity objective explicitly tasks the FCA not to let the UK financial system be used for the purposes of financial crime. In contrast, the Prudential Regulation Authority, or PRA – the sister agency charged with overseeing the safety and soundness of financial institutions – has no such mandate.  Countering financial crime is not part of its remit.  This is deliberate: it gives a clear division of labour between the two authorities.  Give a financial crime mandate to both authorities, and you might end up with muddling overlap or, worse still, buck-passing.

Of course, this does not mean that the PRA can forget about financial crime altogether.  From its prudential point of view, fraud against financial institutions can be a significant source of operational and reputational risk – and so too is non-compliance with the legal and regulatory requirements of overseas jurisdictions. The PRA will need to know financial institutions are on top of these risks, and that their safety and soundness is not at risk.

The FCA’s focus will be different.  Our focus will be on protecting consumers, and stopping firms facilitating crimes for which they can be a conduit, such as money laundering. Other things being equal, the FCA will not see its primary role as being to nanny or bully banks into protecting themselves against fraud.  We presume that banks have natural incentives to do that for themselves.  If they do it badly, their shareholders and bonus-pool participants should take some of the hit.  The Payment Services Regulations also do an excellent job in this connection, by incentivising banks to protect their cardholders from fraud as well.

Of course, this does not mean we have no interest in how fraud more generally is tackled.  As graphically documented by the National Fraud Authority in recent years, there are significant social costs of fraud.  The fraudster who is blocked by one bank’s defences may move on to another, or directly con members of the public, or go in for a different line of crime altogether. 

The country’s overall response to fraud requires not only robust systems and controls in financial institutions, but also a concerted public and private sector strategy.  This is why we are an active and supportive participant in the Economic Crime Coordination Board (the ECCB – the precursor to the Economic Crime Command) and its prevention, intelligence and operations groups.

The challenges for the ECCB are considerable – to set out a coherent strategy and identify strategic priorities, to develop a tasking and coordination mechanism that appropriately mobilises autonomous agencies in furtherance of those priorities, and to devise a successful model for mutual engagement between public and private sectors.  And all this at a time of diminishing public expenditure on criminal law enforcement, which makes efficient employment of available resources all the more important.  We all have a stake in helping to see that these challenges are met.  The FSA’s engagement with the ECCB, which will continue into the FCA,  indicates how seriously we take that responsibility. And, of course, alongside that, we continue to work closely with other law enforcement agencies, here and overseas, in order to pursue our objectives.

Against that background, let me turn to one or two areas of current and future FSA/FCA activity.

Investment fraud

Criminals, both here and abroad, defraud investors in Britain of hundreds of millions of pounds a year through scams such as share-sale (or ‘boiler room’) frauds, landbanking scams, rogue carbon-trading firms or fraudulent collective investment schemes. Investment fraud remains one of our top financial crime risks.

Those who invest their money in such schemes are not protected by the Financial Services Compensation Scheme if they invest with businesses that are unregulated, and all too frequently lose all their money.

We recognise that tackling this activity requires us to attack it on several different fronts. 

So we take a robust line against firms and individuals who break the law by conducting regulated activities without authorisation, making regular use of our criminal and civil powers in this regard. 

By way of example, in the past few months we have executed search warrants and made an arrest of an individual who we believe was operating an unauthorised foreign exchange investment scheme. 

We have frozen the assets of a landbanking company that we believe was selling relatively worthless land as an investment opportunity.

And, in completed cases, we worked with the Crown Prosecution Service and the City of London Police to secure the conviction and four-and-a-half year sentence of Michael McInerney who helped launder money for Tomas Wilmot, a share fraudster who himself was convicted last year and sentenced to nine years imprisonment along with his two sons who each received a five-year sentence.

Equally importantly we also seek to remove victims from the picture by alerting the public to the dangers of investing in such schemes including by, for instance, proactively writing to those we identify through intelligence, as being on the target list of fraudsters.  This year we wrote to 76,000 people who we found were at risk of being targeted by investment scams.  And we have provided consumer guidance to many millions through our media work and by providing educational videos on the main types of investment scams.

We also use the courts to help victims of investment scams to get some compensation.  This has involved us freezing £33m in the last 18 months, which we hope to return to victims once cases are concluded.  And in the case I referred to earlier, confiscation proceedings are ongoing relating to the assets of the Wilmot family and their associate Michael McInerney. Depriving criminals of their ill-gotten gains is a key aim for us, and this is a tool we will not be shy of using in future.

That is what we are doing to combat investment fraud. But it is not all about us. The industry also has a role to play.  Most money which passes to a fraudster in these schemes goes either from or to (or sometimes both) a UK account.  Our recent thematic review of banks' defences against investment frauds looked at the steps firms take a) to protect their customers, and b) to detect when they are providing banking services to people perpetrating these scams.

Our review found many examples of good practice, and individual staff members with a strong commitment to protecting customers, but we saw little systematic focus on the specific issue of investment fraud. While some bank staff made real efforts to warn customers who were about to fall victim to investment fraudsters, other banks are doing very little.

We found no banks could show they allocated resources to this issue on the basis of purposive risk assessment or senior management decisions: efforts to protect customers from this type of fraud were worryingly haphazard.

We also had real doubts about some banks' ability to detect where they are offering banking services to the fraudsters themselves, which is essential if banks are to comply with their AML obligations. This is really basic stuff and we expect the industry to do it right.

We published draft guidance to the industry in June, and the BBA submitted a detailed and helpful response, which includes a request for greater intelligence sharing with the regulator, both on individual cases and on fraudulent techniques.  There will always be limits to what can be shared, but we are keen to explore more fully with BBA what scope there is for improvement.  Meanwhile, we plan to publish our final guidance, which will contain amendments to clarify many of the points raised by respondents, in November.

High-risk customers

And on the topic of guidance.

It is now over a year since we published our findings on how banks handle customers and situations that present a higher risk of money laundering –serving politically exposed customers, for example, which means overseas public officials who may be able to abuse their position for personal gain. Other types of high-risk activity include providing wire transfers or correspondent banking services. 

You will recall we were very concerned by our findings.

You will also have noted that several enforcement actions have followed.

On 2 August this year, we fined Turkish Bank (UK) Ltd £294,000 for failing to meet the Money Laundering Regulations' requirements related to the provision of correspondent banking services.

In May, Habib Bank AG Zurich was fined £525,000 for failing to take reasonable care to establish and maintain adequate anti-money laundering systems and controls. We also fined Habib's money laundering reporting officer personally £17,500 for his failures in ensuring the bank had adequate anti-money laundering controls.

And in March we fined Coutts and Co £8,750,000 for its failings in relation to high-risk customers.

At the time of our thematic review we made it clear our focus on AML controls would continue.  Twelve months on, you might like to reflect whether your institution has a convincing story to tell. What practically has changed from before? Have you looked again at your risk appetite, and whether it is properly reflected in the customers you have on your books?  Has the way you treat the highest risk customers on your books altered? What evidence is there your institution – and your senior management – are on top of this issue?

London is a world-leading financial services centre.  Businesses here should grow and flourish by offering excellent service, nurturing client relationships, and showing peerless expertise.  Firms should not seek to grow by taking grubby money from shady people or by turning a blind eye to the risk of doing so.

I might pause for a moment here to reiterate what the FSA is looking for from AML controls.  That is a proper assessment of the risks a particular customer or type of business poses and a proportionate and effective way of managing that risk.   We do not require all customers to have the same type of due diligence.  We do not specify how many forms of ID should be produced. 

We do not, apart from PEPs, specify what constitutes a high-risk customer.  These are judgements you are both best placed, and obliged, to make. 

Trade finance

Looking at the future, a new thematic review, which we are just beginning, will look at how banks that finance international trade control the financial crime risks in these businesses. Trade finance seeks to ensure exporters (who are worried they might not be paid) and importers (concerned they might not receive their goods) walk away from the transaction happy, with banks standing in the middle to vouch for their customers and make the transaction work. You could argue the whole setup is intended to prevent financial crime – whether that is a fraud committed by the seller or by the buyer.

But there are many ways international trade can be abused. For example, practices such as under- and over-invoicing can allow criminals to transfer value between countries – say, claiming a shipping container is full of mobile telephones with a certain value when in fact it is empty – while an underlying fund transfer shifts the money with an apparently legitimate paper trail. Likewise, some customers may seek to conceal that a shipment in fact breaches trade embargoes. To what extent can banks, which only see the documents and never handle the physical goods, detect this type of abuse?

Our project will visit a range of banks to understand current practice, focusing in particular on the risks of letters of credit and bank collections. We will publish our report next summer.

Systemic Anti-Money Laundering programme

Thematic work will continue to be a key part of the FCA’s approach but it will not be all of it. A new feature of our AML supervisory strategy is for us to mount systematic, recurrent, in-depth reviews of the biggest banks’ defences against money launderers and sanctions breaches. This ‘Systematic Anti-Money Laundering Programme’, piloted over the past year, is a new venture for us; it will be applied to the largest banks operating in the UK (and not just high street retail banks – several investment banks too), with reviews of one institution or another taking place on a permanent basis.

The ‘Systematic Anti-Money Laundering Programme’ will mean the FCA will take a view on an ongoing basis of how robust the anti-money laundering and sanctions defences are in the banks that act as gatekeepers to the vast majority of the financial transactions in this country. 

What will it look at?

We will consider each bank's anti-money laundering defences as an end-to-end process – with new customers entering at one end, and suspicious activity reports coming out the other, and all the intermediate stages probed to see how well are they tied together. How well do various parts of the institution communicate with each other? Are some risks falling between the gaps?  Are the bank’s highest risk customers being given the right level of due diligence and monitoring?

All in all, the systematic programme will help us achieve the FCA's aim to intervene earlier to minimise detriment to consumers and society as a whole.

A crisis of confidence

Most of you will have heard FSA speakers on many occasions talking about banks’ defences against financial crime, and about our regulatory interest in robust systems and controls that make it hard for financial criminals to take advantage of the vital products and services that banks supply.  And you’ve just heard me talk along similar lines today.  But now it is time to face up to the fact that there is an elephant in the room. 

All summer long, LIBOR-rigging, money-laundering and sanctions-busting have filled the pages of Britain’s newspapers. An industry suffering a crisis of public confidence as a result of the financial crisis itself, as well as of mis-selling to retail and small business customers, has sunk further in the public eye.  ‘People are angry with banks and bankers.’  The LIBOR scandal reveals ‘a dealing room culture of cynical greed’.  There has been ‘a collapse of trust in bankers’.  These remarks are not drawn from the pages of Private Eye, or even a Treasury Select Committee report.  They come from my boss, the chair of the FSA, Lord Turner. There is a real problem here that needs to be fixed.

So what is to be done about it? 

Clearly, there has to be intense and well-focused supervision.  The FSA has got better at that in recent years, in relation to firms’ defences against financial crime as well as in other areas.  And the FCA will build on that.

Next, there has to be robust enforcement action.  Take it from me:  there will be.

Ultimately, however, we would much prefer to see more prevention to avoid the need for the cure.  To highlight two things which are vital for that:

First, there needs to be strong management commitment to better culture and better values.  The managers of banks need to understand that they are guardians of the public interest, and not just of profitability.  Nowhere is this more true than in relation to money laundering and other crimes that hurt society.  If there is a single sentence that sums up what we saw when we looked at high money- laundering risk scenarios last year, it is this – that again and again we saw the desire to win and keep the business trump the obligation to honour the AML rules fully and in good faith.  That must change.  To quote Lord Turner:

‘Unless management and boards themselves shift the tone from the top … and in addition make effective controls against dishonest behaviour the highest priority throughout the organisation, then we are not going to change the external perception of bankers”

The other vital thing is to sort out the incentive structures by which individuals are motivated and rewarded.  Culture does not exist in a vacuum; nor can it be changed by exhortation alone. 

The incentive structures which can drive individual behaviour have to be aligned with the high values proclaimed by the firm.  The FSA made an important start here nearly three years ago with its remuneration code for the highest earners. We are currently consulting on proposed guidance on incentive schemes for other staff in financial institutions, because of the real risks that they pose in relation to mis-selling. 

This is not the right place for a technical analysis of the bearing of the remuneration code on financial crime risks.  Indeed, to be quite frank, technical analysis might distract us from the key point, which is this…

…Just as banks must make sure their remuneration structures do not foster prudential risk and consumer detriment, so you must make sure that your remuneration structures do not aggravate financial crime risk, and indeed that they militate against financial crime risks.  People should be rewarded for doing the right thing – which might include turning away business – not just for the short-term income they generate.  This will be an area of ongoing interest to the FCA.

And I say ‘short term’ advisedly.  That income, whether from mis-selling or financial crime, comes with a poisoned tail.

The events of this summer have made that clear – if it wasn’t already. Banks are still picking up the tab for behaviour that took place five or ten years ago.  All the more reason, surely, if you have the long-term interests of your own institution at heart to be fully getting to grips with questions of culture and incentives now.

It is in all of our interests, as members of the public, to see financial crime tackled, to prevent dirty money being laundered, to ensure those who are prepared to break the law for their own benefit are punished.  The FSA, and the FCA, are committed to playing our part in that. We expect you to do so too and look forward to working with you to achieve that.