Deep Dive Episode 58 – LIBOR – Will a $200 Trillion Global Benchmark Disappear – or Not?

LIBOR is a hugely important interest rate benchmark, used globally and embedded in over $200 trillion of financial contracts. It has its notable shortcomings, including having been subject to scandalous attempts at manipulation. Financial regulators, notably the New York Fed, want it to disappear and be replaced by another index. But can the regulators succeed in their effort? Will LIBOR disappear and be replaced? By SOFR or something else? Or will it survive, perhaps as one of multiple competing benchmarks?

Dr. Oonagh McDonald thoroughly explores LIBOR’s evolution, scandals, and the issues of its future in her new book, “Holding Bankers to Account.” Oonagh will present the lessons of history and the state of current debates. Gary Kalbaugh of ING Financial and Columbia Law School and Alex Pollock of the R Street Institute will be discussants.


Although this transcript is largely accurate, in some cases it could be incomplete or inaccurate due to inaudible passages or transcription errors.

Operator:  Welcome to Free Lunch, the podcast of The Federalist Society’s Regulatory Transparency Project. All expressions of opinion are those of the speakers.

On June 5th, RTP co-sponsored a teleforum call with The Federalist Society’s Financial Services Practice Group, which discussed the future of LIBOR as an important global interest rate benchmark. The call featured the insights of Professor Gary Kalbaugh from the Maurice A. Deane School of Law, Alex Pollock from the R Street Institute, and Oonagh McDonald author of Holding Bankers to Account. We hope you enjoy it.

Wesley Hodges:  My name is Wesley Hodges, and I’m the Associate Director of Practice Groups at The Federalist Society.

As always, please note that all expressions of opinion are those of the experts on today’s call.

Today, we are very fortunate to have with us Dr. Oonagh McDonald, CBE, who was a philosophy lecturer at the University of Bristol, a member of the British Parliament in 1976 to 1987, and a member of the Front Bench Treasury Team, who is an author on many books, including one on Freddie Mae and Freddie Mac and the Leman Brothers crisis and, today, the author of the new book the Holding Bankers to Account that we’ll be discussing.

Our next speaker today is Professor Gary Kalbaugh, who is Special Professor of Law at the Maurice A. Deane School of Law. Also with us today is Mr. Alex J. Pollock, who is the Distinguished Senior Fellow at the R Street Institute and, in his misspent youth, also a philosophy major. After our speakers give their opening remarks today, we will move to an audience Q&A. Thank you very much for sharing with us. Dr. McDonald, the floor is yours.

Dr. Oonagh McDonald, CBE:  Thank you very much indeed and thank you very much for this opportunity to talk about my latest book. I seem to be specializing in writing about misbehavior in the financial world. And this time, the main misbehavior that I decided to look at is the misuse of LIBOR. LIBOR had been a really well-established benchmark until beginning in the 1980s — for syndicated lending. And beginning in the late ‘80s, early ‘90s, it began to be applied to derivative contracts, as well. We move time on until 2010 when the investigations began to be undertaken by the Financial Services Authority in the UK — later, the Financial Conduct Authority.

And the investigations covered six banks: Barclays, UBS, Rabobank, Deutsche Bank, Citi Bank, and the Royal Bank of Scotland. What were they talking about? They were talking about — which had previously been discovered, I think, by the Wall Street Journal in its articles in 2008. What were they talking about? They were talking about a group of traders very often lead by one called Tom Hayes, a trader who moved from one bank to another and who is now currently residing at Her Majesty’s pleasure, as we put it, in the UK. I think he’s got a few more years to serve. What these traders decided to do was to encourage their submitters to put in a rate in answer to the question of “at what rate would you be able to borrow from other banks?” to summarize the question, in terms of unsecured borrowing.

At what rate would you be able to borrow at? Well, the traders got together, clearly colluded with each other, and sought to alter those rates by one, two, perhaps, three or four basis points. Why did they do that? In order to make sure that their derivative contracts ended at a rate of interest which would suit them and increase their profits for the bank, as well as their own bonuses. The extent to which that could actually occur I think is something we can discuss a bit later on. But usually, there were about six of them. Now, they actually colluded with each other through emails and through the electronic chat rooms. And I’ve included large extracts from those in my book just to make it clear that it was perfectly obvious what the traders were up to.

They explained it to each other. They agreed what rates they would submit. They sent presents to each other, and they expressed their pleasure when they thought they had the rate which would suit perhaps two of these traders on one day and another rate which would suit three or four of the traders on another day. So it was all quite open to view, and that is a very important point because, towards the end of the book, I want to talk about holding senior managers to account. Why do I want to do that? Because I don’t think it’s enough that traders alone should be held to account. They lost their jobs, or they were fined or faced, perhaps, imprisonment as well in some, but not all, cases. Meanwhile, the senior managers, who should have known and could easily have known what was going on, were not held accountable for what happened. Instead, their banks were fined.

So that’s one strand in the book that I discuss in some detail but, particularly, at the end. And at the end, I talk about the way in which senior managers could be held responsible, in terms of the UK senior management regime. But that’s a topic we can talk about later. Then, I want to go back to the way in which I constantly read, particularly in the press here, LIBOR is described – it’s described as the scandal-ridden benchmark. And that, I think, is now grossly unfair. So what I’ve described in the book in some length is what has happened since then to change — to transform that benchmark.

First of all, you have to know that the regulatory authorities in the UK were not responsible for the supervision of LIBOR. That, instead, rested with a trade association called the British Bankers Association – the trade association, yes, not objective enough. Though, the only thing that could be said by way of justification was, since it was not a regulatory authority, it hadn’t got the powers to investigate or the resources to investigate what was going on. But that’s only a limited excuse since, although they themselves lacked the powers and resources, they did nothing to communicate that to the regulatory authorities in the UK. All of that has changed.

By 2013, following various reports, the regulation and supervision of LIBOR was transferred to the Financial Conduct Authority, which came into existence by then. And its administration was passed over to ICE benchmark administrators. And I have gone through exactly the way in which every effort has been made to ensure that LIBOR is properly regulated. And I think I’ll mention just two or three of those. It would be quite a long story to explain in full detail.

First of all, IBA looked at the way in which LIBOR was actually recorded. They altered the question to extended it from interbank lending to wholesale market funding, looking at multilateral banks, central banks, money markets and so on. So it’s a much wider net than it was before.

Secondly, the submitters have a code of conduct, and they cannot consult with the traders as to the rate which they provide each day.

Thirdly, there is an oversight committee composed of market participants, representatives from the Swiss National Bank and the Bank of England to keep an eye on what is actually going on on a day-to-day basis. And I think, now, if you wanted to manipulate the rate, you would find it rather difficult because you do not know what rate any other bank submitted until three months later. And then, you only know that on an unattributed basis. So if you did get together as a trader and tried to persuade these submitters to submit the rate that you wanted, you would have no idea whether or not your co-conspirator had actually done what you expected them to do.

So I think there’s very little point in trying to manipulate LIBOR now and very little ability to do so. Just a note on that, I mentioned Tom Hayes, who lead the various conspiracies to manipulate LIBOR. Apparently, when he was engaged in long conversations with these Serious Fraud Office and was shown the documents that they had collected by way of evidence, Tom Hayes was very disappointed to discover that, although he thought his co-conspirators were agreeing a particular rate, they often lied to him and didn’t submit the rate that he expected. I don’t know what that tells us about honor amongst thieves, but I find it quite amusing that he was upset by this.

So I would say that journalists who write about scandal-ridden LIBOR are several years out of date. And I think I expect journalists to give me the latest news and not dead news. So I think the term “scandal-ridden” should be abandoned.

And then, the third thing to mention is work had just about been completed at the time of writing on SOFR, the overnight alternative to LIBOR, and on the Bank of England’s SONIA, which is their overnight alternative to LIBOR. I discuss briefly that neither really fits the bill because neither can provide a yield curve, which is what most users of LIBOR actually wanted.

So therefore, I think the time has come to consider should LIBOR be retained, or should it be abandoned by 2021; a timescale which seems to me is getting pretty short right now. I think that that’s all I need say by introduction because I’m sure the others have many comments to make. And then, I can respond to their comments.

Prof. Gary Kalbaugh:  Well, thank you very much, Oonagh. This is Gary Kalbaugh. I’ll take the first shot at making some comments. You’ve put together one of the best collections of the internal narratives that the LIBOR manipulators engaged in. And I found it entertaining, candidly, to read some of them. And your history of these markets was an absolute joy to read in the first few chapters. One thing I was struck by when I read those internal narratives was how petty some of the inducements were that induced individuals to corrupt a multitrillion dollar market. An example is, in your book, there’s a dialogue related to Swiss francs, where somebody is twice told “It would make you the best guy ever,” in an instant message.

And the person says back, in effect, “Okay. I’ll manipulate it. I’ll change the number I put in to be accounted for in calculating in LIBOR.” And he gets back “UR the man” – the letter U-R. In another case, somebody did it for mere love because it says — submitter — “The trader who want to manipulate it will love me,” one person writes. And the other person says, “Hahaha, so do it.” It wasn’t like there were large bribes or things that might even threaten to corrupt the most upright individual. This is really to get a friendly text message — that it seems many of these individuals who had this trust violated it.

Your answer, though, is something I want to delve into a little bit because your answer seems to be a better regulatory framework. And I’m going to get back to that. I did wonder, as I read it, whether there’s a more fundamental cause in our culture – a cause that the solution may not be better regulation. We do keep on seeing—and over here, we see it as well—government as a solution for dishonesty. And I have to wonder how all of these intellectually talented young people graduate from the top universities globally, enjoy social stature and economic benefits, all the while lacking a moral compass. One that, in times past, people who maybe left school in the eighth grade would have been expected to have.

Is it hubristic, I would ask, to think that regulations will solve this when someone is already largely formed and is in his or her 20s or 30s? And just before I bring the floor back to you, we seem to assume that fear of regulatory consequences will somehow amend flawed immorality of men and women. In this case, it appears just men.

Dr. Oonagh McDonald, CBE:  Yeah, those markets are still just men.

Prof. Gary Kalbaugh:  Yeah, in the narratives in your book, it seems like it was mostly — or all men that are referenced. But maybe what needs to be culturally addressed is the lack of what I’m going to term—and this is a quaint phrase—the fear of God. Because the fear of regulatory consequences seems to pale in comparison we seem to see time and again. So maybe the downfall of even public religion and the morality associated with it is approximate cause of people who are supposed to represent our supreme values instead betraying our most fundamental values.

I also wanted to, finally, just address the manager statement of responsibility that your book mentions that the UK has implemented. And it seems like a good idea. The idea is to have senior managers provide regulator statements of what their jobs are and what they’re responsible for. I do struggle with the idea of a regulator determining what’s called “fitness and properness,” which from the American ear sounds very British, of bank management. We have a vaguely similar concept for national bank charters in the United States. And candidly, I’d look at those just as critically. What does give regulators better, or even merely equal, insight to shareholders on fitness and properness? Who are regulators? I mean, they’re individuals, some of whom are older and more experienced, and many of whom are not experienced at all and may be recent graduates.

And I wonder on what basis would they be able to determine that. I know the criteria are enunciated. It seems like it also has the potential to exclude non-traditional candidates from being senior managers in banks or act as a soft ban from the industry without any due process for people who are disfavored or accused of wrongdoing.

And the last thing I just want to note, Oonagh, is that your book cites some outstanding academic studies questioning whether the actual LIBOR calculations went astray. And it seems to even make us wonder was LIBOR robust enough to survive this blatant manipulation? And your arguments for retaining it I found compelling. And I just wonder, with Randy Quarels from the Federal Reserve—the Vice Chair—warning banks just two days ago to expect the end of LIBOR, is there any hope? Let me feed it back to you.

Dr. Oonagh McDonald, CBE:  Okay. Well, lots of questions there. First of all, yes, I was amused at first by even the bottle of Bollinger champagne being regarded as sufficient. But what I have to remember as well that that is — what they were really doing was ensuring that their bonuses were much higher than they should be, or would have been, because it was the individual trader who would be rewarded for the profit that he was providing for the bank by the way in which he traded. So yes, you’re quite right that the exchanges between the traders are superficial enough. But behind that lay the opportunity to vastly increase their bonuses.

And what each particular trader had done would, of course, be recorded. You’ll note that I referred to Barclay’s Chief Operations Officer, who disingenuously suggested that they wouldn’t be able to see that in the P&L. Well, yes, that was absolutely disingenuous because, behind that, how could they pay bonuses to each particular trader depending on the profit that they had gained for the bank unless they actually looked at what each individual trader had succeeded in doing with a particular contract for which they were responsible? So it’s a bit deeper than all this interchange between the traders.

Moral standards – yes, I think that’s a big question. I think it could, perhaps, be partly — no, there’s another point I should make, which actually a CO of Barclay’s made. He said, “At best you were talking about, say, 14 traders. We employ many more than that.” So perhaps, we are focusing too make on just the bad apples and calling that into question — calling everybody into question. Although, I agree with you, but that’s much too big a topic for now. I agree with you that there appears to be a loss of moral standards. And that is something I would probably agree with your sentiments on. Okay.

Fit and proper – I suppose we’re so used to the term “fit and proper” in the UK. Fit and proper, honest and competent. Does an individual regulator determine that? No. It is very much a question of looking at the person’s previous career. It will also be a question of examining that person’s reputation. At a more senior level in the city, despite fairly frequent changes of appointment, I would say that people who are coming up for senior managers appointment — or even a member of a board — I was authorized to serve on both commercial and regulatory boards by the SFA.

So it’s very much finding out about a person’s reputation, standing, how they had managed business elsewhere or at a more junior level. At one time, the regulatory authorities — I think it still persists — the SFA certainly had what they called grey panthers. And you can guess that those were bankers—hence the name grey bankers—who knew the scene pretty well and who could aid in determining who was eligible, in that sense, to become a senior manager. So it very much depends on honesty and competence as determined by your reputation and your previous work in the industry. And certainly, an individual regulator would not be determining that and certainly not a junior regulator would be determining that for a senior person in the industry.

Your whole appointment and your whole career would be reviewed by the senior regulators. They do, however, make mistakes. There’s some pretty awful mistakes with the cooperative bank in recent years. So it’s not foolproof. But then, I regret to say that nothing is foolproof — absolutely foolproof.

Senior management assigning the duty of responsibility – well, I look at — and indeed, the purpose of the duty of responsibility is senior manager sets out exactly what he’s responsible for and that his role is to ensure, to the best of his ability, that the work carried out by others for whom he’s responsible is both compliant and well done.

In my view, the advantage of the duty of responsibility is, if you find you should be holding a senior manager responsible, then you’ve got a signature to his statement which, I think, puts you in a strong position as a prosecutor in a court of law.  Your defense, then, is you took all reasonable steps to ensure that what was carried out by others under you was properly done. And why am I glad now? If this goes back in history — and I do mention the history. I was on the board for the collapse of Baring Brothers, which was horrendously badly managed when you dug around. And at that time, neither company law nor Financial Services regulations enabled us to hold senior managers responsible.

So I was actually there on the enforcement committee when we read all the papers and discussed what should be done. So that’s my background to that.

Alex J. Pollock:  I am going to focus a little more on the financial aspects of LIBOR itself, which are wonderfully discussed in this book. And let me say, in general, Oonagh’s book is really interesting and useful. And I agree it’s a great history of the development of LIBOR in the context of the evolution of the London banking market itself over several decades. And the market inventing something which worked well as it was required by the times. Then, of course, we got the scandalous behavior, which has been discussed, with great foolishness put into emails and chatrooms, as you have said, great foolishness, but then followed by a lot of reforms, as Oonagh has discussed.

Also, there is the issue of — as intolerable as the behavior was, how much did it really change the outcome of what was posted by LIBOR?  Oonagh, you and I have discussed this personally, and I have with other experts. I think nobody really knows, but guesses are maybe one or a couple of basis points and probably in symmetrical fashion so that, on average, there probably wasn’t a bias to the rate. So if that be true and it be true—which we know it is true that there have been major serious reforms—does it follow, which is the argument that the central banks are making, that LIBOR should be junked? Or should we consider it improved and continuing? As has been mentioned, we’ve had numerous announcements now from central banks that they want LIBOR to end, most recently by Mr. Quarel, as was mentioned, this week.

And as our title says, this is a benchmark which is included in something like $200 trillion, with a T, of financial contracts. Is it so clear that ending it and trying to invent something else to take its place is the best idea? And Oonagh’s book does point out a couple of times the interesting contrast. And this was a market evolution that created LIBOR. But now, what we have is a top-down regulatory — mostly central bank directive to say the — as Mr. Quarel said the other day — “The end of LIBOR is coming.” And several banks have propped up LIBOR substitutes — SOFR, as Oonagh mentioned, the secured overnight financing rate. And as the book discusses, the name itself displays very well-known problems with this rate.

First of all, it’s secured instead of an unsecured rate, which LIBOR was and is. It’s secured with government debt, which makes it basically a short-term, extremely low-risk or so-called riskless rate, effectively, without a credit component. Whereas, a key idea of LIBOR was always you were measuring the riskiness of the banks against the government debt, the so-called debt spread. It also doesn’t have a liquidity component for private liquidity risk. It’s not a bank risk or a private risk. It’s a government risk. And also as indicated by the name, this is an overnight rate, and there is no SOFR yield curve. As Oonagh’s book says, the problem with overnight rates is they cannot fill the place of LIBOR. And it seems to me that’s right.

So what has happened is the central banks—many central banks but notably the Fed—are busy trying to address this no-yield curve problem to create, or to derive, a benchmark yield curve from derivatives — from future contracts, which guess the average course of SOFR? Well, this is funny. So you create a derivative to determine the cash market price instead of a derivative with an underlying cash instrument. On this effort, I want to quote a recent — a 2019 paper published by the Federal Reserve Board about these efforts.

It says this. “Inferring forward-looking term rates,” and it says “Forward-looking term rates are considerably more difficult to estimate because they require that one infer market expectations from a limited set of available information. Invariably, such inference involves imposing some assumptions that restrict the shape of the path of forward rates. In our model,”—our being the Fed—“we expect the expected forward SOFR rates are assumed potentially jump up or down on scheduled federal open market committee policy rate announcement dates but remain constant in periods in between. This assumption greatly reduces the complexity of the estimation problem.” Well, I’m sure it does, but that’s very different from observing transactions.

Dr. Oonagh McDonald, CBE:  It is indeed.

Alex J. Pollock:  I think we have to wonder whether the sorts of assumptions and judgements that go into such an effort of trying to create the yield curve for SOFR are superior to the sorts of judgements that go into the LIBOR surveys. And it’s not at all clear to me that they are preferable. You might do, as a friend of mine with long Treasury experience said to me, “Well, just take” — and this is not unlike the reforms of LIBOR. “Just take the broadest possible set of money market transactions,” he said, “that is to say all interbank loans, plus any bank CDs not necessarily between banks, all bank time deposits, all prime commercial paper issued, and a very important addition, the short-term notes of government sponsored enterprises” — certainly dollar for dollar, which is a very large market and very tightly connected to bank financing — “and maybe T bills, too. And then, find the median maturity,” he said — “the median rate by maturity by volume waiting or something.”

And that would be the idea of creating a benchmark from a much broader set of observations, which I think is consistent, but a still broader idea than the LIBOR reforms suggest. And it seems to me worth considering. But overall, I think as we consider this problem, as Oonagh says in her book, “all that can be said with certainty at present is that LIBOR is not yet dead — that when, and whether, we can expect it’s obituary in the next few years remains uncertain.” And that seems right to me. And it may very well be that we’re going to end up with a system of multiple benchmarks, of which LIBOR may very well continue to be one, which would compete with each other in the market.

Dr. Oonagh McDonald, CBE:  Yes. First of all, I think that you’re quite right. A number of attempts have been made to ensure that the SOFR and SONIA can be forward-looking. And it appears that there are a number of difficulties in that. Interestingly enough, more work is being done on the difficulties of — and actually introducing other elements of risk into what it supposed to be a risk-free rate. Because once you start extending it into the future, then various problems begin to arise. For example, as you’ve rightly pointed out, you don’t get the element of credit risk of your counterparties, which is, of course, what LIBOR was meant to take into account — which is very important. If banks are still going to link, or are going to link, mortgage lending, car loans, and so forth to one of these new rates — that they need that element. And that was what was built into LIBOR. So I think that’s one of the issues that has arisen.

Another issue is that SOFR needs to — will have to be sensitive to the supply and demand conditions of the U.S. Treasury market. And that, in itself, will produce yet another element of risk. That future increased riskiness is like to be passed on to the borrowers, if, of course, they agree to accept the higher prices that might — should be incurred. So a great deal of work is being done — technical work is being done to try and make these kinds of benchmarks have a forward look. I don’t think it’s going to be very successful.

They have been called into question by the Bank for International Settlements and, indeed, by the Financial Stability Board’s latest report, as I think you’ve already mentioned. So riskiness there. But particularly Randall Quarel’s efforts to move forward very quickly suggest to me that he has no idea of what is being involved. We actually put $200 trillion. I see that Bloomberg is talking about $270 trillion worth of outstanding contracts — no, sorry, $370 trillion outstanding contracts. IBA itself talks about $300 trillion outstanding contracts eventually needing to be changed. Now, the banks are supposed — banks generally haven’t evolved on this process. I think there would be two reasons for that. One is that it is not entirely clear as yet whether the administration of SONIA or SOFR complies with IOSCO principles for benchmarks.

But given that that can be expected to occur, banks are supposed to be monitoring everything that they have in the way of outstanding contracts. Well, first of all, they’ve got to find the existing LIBOR transactions; estimate how much exposure the institution has to LIBOR; how the transition will effect hedge effectiveness, interest rate risk, basis risk, and valuations; understanding full bank language in existing contracts, whether or not the legacy contracts determine — trigger events and what they might be; create the language for new LIBOR transactions; assess accounting, tax, and IT implications; and then, tell your customers and counterparties that you understand — to make sure they all understand the risk and the benefits of the move to the new index.

Alex J. Pollock:  To which they might not agree being the other side of the contract.

Dr. Oonagh McDonald, CBE:  Exactly. So that, should we say, is just one of the problems. But that is the schedule of work that banks are supposed to undertake. And LIBOR is supposed to be withdrawn by the end of 2021.

Alex J. Pollock:  Oonagh, I think that’s such a wonderful list of things. And given that, why are the central banks—the Fed in particular—so insistent on this and on the short dates?

Dr. Oonagh McDonald, CBE:  I am not quite sure why the Fed — I mean, there are things that I could say about that, which might not be terribly polite, but which might say, well, LIBOR was never an American benchmark. [Laughter]

Prof. Gary Kalbaugh:  Oonagh, if I could just throw a thought on perhaps the motivation?

Dr. Oonagh McDonald, CBE:  Yes, please do.

Prof. Gary Kalbaugh:  On the one hand, we have SOFR, a benchmark that would be based on actual market transactions with maybe an extrapolation from there in order to have firm transactions or to account for unsecured trades. And then, we have LIBOR, which needn’t depend on actual transactions in the market and for which the market may have change such that banks do not lend to each other unsecured very much anymore. And you know, LIBOR — I was a little bit critical of some of the regulatory framework that might need to be around LIBOR if it were retained. And maybe because SOFR is an actual market with a lot of depth in actual transactions—and based in actual transactions—maybe it’s harder to have the type of manipulations that occurred with LIBOR.

Dr. Oonagh McDonald, CBE:  Yes, but then, if you’re not dealing with the sensitivity to changes in the U.S. Treasury market—which do impact on the benchmark—or if you’re not taking into account credit risk, those two risks are important in any benchmark which is supposed to be forward-looking. Obviously, for overnights, it’s absolutely no problem. Though, even there, an average is taken. It’s not the overnight as stated every day. So that’s one issue. Now, going back to LIBOR, what has been done—and I mentioned some of the extensions that have been made—is yes, it’s true that banks don’t lend to each other as much as they used to. I guess that could change as time goes on and memories of the way in which bank lending into bank lending dried up, particularly after the collapse of Lehman Brothers, begin to fade.

That could possibly change. But any way, the two changes that have been made — one to extend the range of transactions which can count, as I mentioned to you with central bank lending and so forth. And the other is in the way in which the expert judgment has been handled. That is not just — as there always an element of subjectivity in LIBOR, it is not just subjectivity. It is looking very closely at the proper mathematical means of extracting from the transaction data that each particular bank already has. And that is very much carefully overseen and regulated by IBA and, in turn, by the SCA. So I think that element of subjectivity has been, to a large extent, reduced in LIBOR.

But you are right. That did already exist. But then, when you’re looking at large liquid markets, yes, that’s fine. But if you can’t take a justifiable forward look, which is what is needed in many cases, then that seems to me that that is quite a serious weakness in the two new overnight benchmarks. Looking around a bit more widely, it is interesting to see that Japan is retaining both its own overnight and its own version of its own IBOR, for example. And I would argue that I would not remove LIBOR as a benchmark, certainly not immediately. And I’ve given you the long list of tasks that each bank would have to undertake. Now, as we all know, there’s considerable riskiness in each of those tasks to be undertaken by a bank, as well as the day to day running of the bank.

And I will mention just one, which we all know has problems. Changes in your IT system in process — well, we all know that you send it out to consultants. They recommend a particular IT system. Then, it has flaws in it, and then, it doesn’t work in the way in which its expected. And then, you have to go back and correct all those flaws in the system and so on. So I think that there are considerable risks, particularly if you try and speed up the process. So I would say to Randall Quarel, I think, at the very least, you ought to hang on — and also to Andrew Bailey. Though, we have yet to hear his final views, which may or may not come out in June or July. I think, at the very least, the time ought to be extended.

Going back to Alex’s original point, did they shift it very much? Well, as we know, there are about 15 or 16 banks that were involved. You took off the top 25 percent and the bottom 25 percent. Might have moved it by one or two basis points. But actually, Alex, it appears that one or two basis points were enough to make quite a considerable difference to the large derivative contracts with which the traders were dealing. So they thought it benefited them. It may have done. And as Mervin King, explaining why they weren’t looking at it during those years, former governor of the Bank of England, said “We were looking at much larger interest rate moves. We were not looking at one or two basis points.” And I think that sometimes it’s the one or two were enough.

Alex J. Pollock:  I think that’s true from the point of view of a highly leveraged derivatives book, Oonagh. But I was thinking of it from the wider group of borrowers and investors in the market. It doesn’t look like very much happened.

Dr. Oonagh McDonald, CBE:  No. I don’t think it did. And as you know, there were various court cases, all of which class actions were taken over the rates of LIBOR concerning mortgages and so forth. And none of these actually — I think it would be fair to say none of these actually reached court because you couldn’t — what you couldn’t say was what the rate would have been had the manipulation not taken place. Even if you–

Alex J. Polluck: I wonder if you–

Dr. Oonagh McDonald, CBE:  Yeah. Oh, sorry.

Alex J. Pollock:  Go ahead.

Dr. Oonagh McDonald, CBE:  No, I just wanted to finish that by saying, and even if you could, then we’re winners and losers. So what were you to do with the winners or with the losers? Hard to tell.

Prof. Gary Kalbaugh:  Right.  Do the winners have to compensate the losers? Where is the wealth transfer?

Dr. Oonagh McDonald, CBE:  Exactly. Yes.

Prof. Gary Kalbaugh:  So I do want to take the opportunity to open up the call to the questions of the folks on the telephone line. I do have a question for you, relating to what I’ll call the Tom Hayes issue.  And you had mentioned that Tom Hayes moved from financial institution to financial institution. I know, in the United States in the banking industry, we also have no way to track that, unless somebody’s been very seriously — has received an industry ban or something like that. But we have no way to track if they left because of something mildly scandalous or even very scandalous.

Self-regulatory organizations in the United States in the securities and derivatives markets do generally track these sort of events, including adverse terminations. Do you have some thoughts on a solution to the so-called Tom Hayes problem?

Dr. Oonagh McDonald, CBE: What is interesting, actually, with the Tom Hayes problem is that one of the banks sorted it themselves. Two managers at a lower level decided that Tom Hayes had a terrific record in being an extremely profitable trader. So they took him on. When the senior managers discovered this, they looked at his record and promptly sacked him. So that was a very good example of senior managers taking whom they employed and looking at their records very closely.

Yes, because we authorize — we call it authorizing, not licensing. I think the terminology has changed somewhat now, but let me revert to the terminology I’m familiar with. Yes, because you are authorizing somebody to move, say, from reasonably senior position to a very senior position, then, they would move into a role where they would have to be authorized. And so their record would be examined. If they move from one company to another, perhaps if they take on a slightly different role, the authorization may not extend to the new role in the new company. So it is possible. I won’t say that it’s always done, but it possible through authorization — the need to authorize specific individuals for senior roles in the whole financial services industry. But that does give us the potential for doing that.

And then, I ought to mention, too, the role of the grey panthers, who are actually employed by the SFA, just spend a lot more time on reviewing individuals and their conduct in any previous positions that they had held. So you could find yourself being refused a position. But the refusal would actually have emanated from one of the grey panthers. I know that that’s something that maybe lawyers are not terribly happy about. But on the other hand, it’s very important information. And it’s important not to have people who are dishonest, unreliable, corrupt in such positions because they can do a great deal of damage before they’re found out again in their new position.

Prof. Gary Kalbaugh:  It does strike me as lacking due process. It makes me think of a private club. If you wish to join a private club sometimes, there’s a process whereby — yeah.  Blackballed, yeah.

Dr. Oonagh McDonald, CBE:  Yes, I think — that’s what it used to be called. I think that — yeah. But I think the information derived from the grey panthers would be rather carefully checked. It would be — of this form. Go take a look at this.

Alex J. Pollock:  Oonagh’s book starts off talking about the history of the development of banking in England, which was very club-like in the beginning of the story.

Dr. Oonagh McDonald, CBE:  Yes, it was.

Alex J. Pollock:  In fact — or a different word would be oligopolistic.

Dr. Oonagh McDonald, CBE:  As the number of banks gradually reduced, yes.

Alex J. Pollock:  Oonagh, I love your idea of putting this whole LIBOR versus SOFR discussion in the context of the century-old competition between New York and London for financial capital.

Dr. Oonagh McDonald, CBE:  Well, I think I will only say this: that the London financial market had a great deal to thank America for, for what it did in the ‘60s and ‘70s.

Alex J. Pollock:  Yes, which are in the book as well. That history, yep. Which launched the Euro-dollar market.

Prof. Gary Kalbaugh:  Yeah. And largely due to overregulation in the United States.

Dr. Oonagh McDonald, CBE:  Yes, that’s right. So that’s why I say thank you. You wanted to comment further on the development and the club-like — did you, Alex?

Alex J. Pollock:  No. Well, I’ll just mention Charles Goodhart, who wrote a book a number of years ago on the evolution of central banks, in which he described the central bank as the manager of the banking club. I’m not sure that’s desirable, but I think there’s some truth in it.

Dr. Oonagh McDonald, CBE:  Well, there certainly was then, and that’s where the so-called governor’s eyebrow is much to the point. But you see, what I tried to explain then was the structure was so different. Yes, a relatively small pool of large national banks. And then, you worked your way up through the bank to get to a senior position. So actually, it would be very reasonable to say that the governor of the Bank of England did actually know all the senior people involved in running a bank. So that’s why I say just the governor’s eyebrow was not quite an absurd expression as it might seem now.

Prof. Gary Kalbaugh:  Sure. In a more intimate environment, that makes sense. I just want to build on what Alex just raised about the competition between — this hundred years’ long competition between — to be the financial center of the world between London and New York. And we mentioned how in the ‘70s and ‘80s U.S. hyper-regulation really resulted in the Euro-dollar market being in the United Kingdom and LIBOR being a determinant in the United Kingdom due to offshore U.S. dollar holdings.

What about the EU benchmark regulation? That regulation now requires benchmarks to be registered with the European Union and has a very prescriptive framework around benchmarks. What do you think about that regulation? Do you think it’s beneficial to the marketplace, or what are your thoughts?

Dr. Oonagh McDonald, CBE:  I think the trouble with EU regulation — first of all, you have to remember that all the other member states, apart from the UK and Ireland, have a code system of law. And they are accustomed to extremely detailed regulations. And of course, those who have recently emerged from the Soviet era are also accustomed to extremely detailed regulations. And I think, from that point of view, there’s a lack of flexibility in EU regulation. And it is over-prescriptive.

And that is why — although, they’ve adopted something like the senior management regime. That is why one element that I really like and approve of about the British regime is that it does say to senior managers “Look. You are responsible for the way in which your business is run. And if you want that responsibility,” as indeed they do, “then you must recognize, also, that you are held accountable for the way in which that is run.” Regulations, to the extent possible whilst a member of the EU — our regulations also formed in terms of our 11 principles, which Sir David Walker first introduced way back in the ‘90s. I always wish it was either 10 or 12. I think he should have had ten principles.

Alex J. Pollock:  11 is an awkward number.

Dr. Oonagh McDonald, CBE:  Well, I like the Ten Commandments. But the principles do determine the nature of the more specific rules that underlie the principles. I’m afraid you have to have rules because people don’t always understand the way in which principles should be applied. But I think it is important to have a set of principles, as well. And to the very greatest extent possible, you should be able to justify the rule, in terms of the principle which dominate your total rulebook. That’s the way in which I approach it — regulation in general. So EU’s too detailed, I’m afraid.

Alex J. Pollock:  Well, that’s consistent with letting LIBOR continue and having a competition in benchmarks over time.

Dr. Oonagh McDonald, CBE:  I think it should. Why not? Provided LIBOR continues to be properly regulated, as I believe it is now, well, then, banks should be able to choose the benchmark that is most suited to the kind of product that they are seeking to sell and the benchmark that is most suited to the nature of that product. Why not?

Prof. Gary Kalbaugh:  It looks like — it’s unfortunate, in a sense. It would be great if we had a huge dispute on this because we could have an interesting dialogue. We are completely in accord, it sounds like, that LIBOR ought to be retained, which, in a sense, was the opening question that’s underlying this whole dialogue. And it sounds like the three of us see merit in it being retained.

Dr. Oonagh McDonald, CBE:  Yes.

Wesley Hodges:  Well, on that note, it looks like we are out of time in our hour today. This has been an absolutely riveting conversation. Oonagh, Gary, Alex, do you have any closing thoughts for us before we sign off?

Alex J. Pollock:  Only thanks very much to The Federalist Society.

Dr. Oonagh McDonald, CBE:  Indeed, yes. I’ve enjoyed discussing it with the other two very much.

Prof. Gary Kalbaugh:  Yeah. Thank you, Alex and Oonagh. It really was great, and I took notes on your answers just because it helps develop thought in this area. So thank you very much.

Dr. Oonagh McDonald, CBE:   Good.

Wesley Hodges:  Excellent. Well, everyone, remember this is Dr. Oonagh McDonald. She’s the author of the new book Holding Bankers to Account. We do encourage you to check that out and pick up a copy or two. So on behalf of The Federalist Society, I would like to thank our experts for the benefit of their very valuable time and expertise today. We welcome all listener feedback by email at [email protected]. Thank you all for joining.

Gary Kalbaugh

Special Professor of Law

Maurice A. Deane School of Law

Oonagh McDonald

Senior Adviser

Crito Capital

Alex J. Pollock

Senior Fellow

Mises Institute

Financial Services & Corporate Governance

The Federalist Society and Regulatory Transparency Project take no position on particular legal or public policy matters. All expressions of opinion are those of the speaker(s). To join the debate, please email us at [email protected].

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