05 March 2013

FSA publishes its Internal Audit Report: Review of the extent of awareness within the FSA of inappropriate Libor submissions

The Report identifies important areas where the FSA should have performed better, and makes valuable recommendations for the future, but does not suggest major regulatory failure  on the scale identified in the Northern Rock (March 2008) or RBS (December 2011)  reports.

The Report identifies that the FSA, at all levels of management, was aware of severe dislocation in the Libor market in the period from summer 2007 to early 2009. However, this dislocation reflected market conditions, and would have occurred even if lowballing had not occurred.

The Report identifies however a number of instances where information available provided some indication that lowballing might be occurring. Of the 97,000 documents reviewed in detail, 26 are judged as providing a direct reference to lowballing or a reference that could, in Internal Audit’s judgement, have been interpreted as such. The two clearest indications relating to a specific firm were the telephone calls from Barclays in March and April 2008, which were included in the FSA’s Final Notice on Barclays published on 27 June 2012.

On the basis of this analysis, the Report concludes that:

• The FSA’s focus on dealing with the financial crisis, together with the fact that contributing to and administering Libor were not ‘regulated activities’, led to the FSA being too narrowly focused in its handling of Libor-related information.
• Taking the information cumulatively, the likelihood that lowballing was occurring should have been considered.
• The information received should have been better managed.

Libor submission and administration will be regulated activities from 1 April 2013 and the FSA, together with the new Libor administrator, will agree appropriate market monitoring and oversight for Libor.

The Report draws out six lessons to be learned for the future regulatory authorities, the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), to consider:

• Activities outside the regulatory perimeter and their implications
• Roles and responsibilities     
• Culture of the regulatory authorities
• How the regulatory authorities use and record information and intelligence
• Circulating and escalating information               
• Record keeping.

The lessons to be learned in relation to lowballing include how the FSA might have better interpreted or responded to the information flows which were available at the time. In relation to derivatives traders however, the Report found no evidence to suggest that there were any communications, or, pieces of information which might have alerted FSA staff to this issue.

The question raised by the Report is whether it would have been feasible to have a supervisory approach in which facts relevant to the derivatives trader issues would have come to light. It is not clear that it would have been, without an impractically intensive supervisory approach. This illustrates that some potential problems cannot be spotted by direct supervision in advance but have to be:

• policed by firms themselves on a day to day basis;
• with effective processes for the supervisory review of firm systems and controls;
• subject to whistleblowing and other procedures to bring problems to light;
• subject to exemplary post facto penalties when offences do occur.

Full information

Internal Audit Report

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