SEC COMMISSIONER KARA STEIN'S DISSENTING STATEMENT REGARDING DEUTSCHE BANK'S WAIVER FROM INELIGIBLE ISSUER STATUS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
PUBLIC STATEMENT

Dissenting Statement in the Matter of Deutsche Bank AG, Regarding WKSI

Commissioner Kara M. Stein
May 4, 2015

I respectfully dissent from the Commission’s Order (“Order”), approved on May 1, 2015, by a majority of the Commission.[1] The Order grants Deutsche Bank AG a waiver from ineligible issuer status triggered by a criminal conviction of its subsidiary, DB Group Services (UK) Ltd. (collectively with Deutsche Bank AG, “Deutsche Bank”), for manipulating the London Interbank Offered Rate (“LIBOR”), a global financial benchmark.[2] This waiver will allow Deutsche Bank to maintain its well-known seasoned issuer (“WKSI”) status, which would have been automatically revoked as a result of its criminal misconduct absent a Commission waiver.

Created by the Commission as part of the Securities Offering Reforms of 2005, WKSI status is available “for the most widely followed issuers representing the most significant amount of capital raised and traded in the United States.”[3] This status confers on the largest companies certain advantages over smaller companies. WKSIs are granted nearly instant access to investors through the capital markets. WKSIs enjoy greater flexibility in their public communications and a streamlined registration process with less oversight than smaller businesses. For example, unlike smaller businesses, the WKSI issuer does not have to wait for the Division of Corporation Finance to review and declare a registration statement effective prior to selling financial products to investors.[4] WKSI companies also enjoy a number of other privileges related to the payment of fees.

With these WKSI advantages comes a modicum of responsibility. WKSIs must meet the very low hurdle of not being ineligible. This means that, among other things, they have not been convicted of certain felonies or misdemeanors within the past three years.[5] In granting this waiver, the Commission continues to erode even this lowest of hurdles for large companies, while small and mid-sized businesses appear to face different treatment.[6]

Deutsche Bank’s illegal conduct involved nearly a decade of lying, cheating, and stealing. This criminal conduct was pervasive and widespread, involving dozens of employees from Deutsche Bank offices including New York, Frankfurt, Tokyo, and London. Deutsche Bank’s traders engaged in a brazen scheme to defraud Deutsche Bank’s counterparties and the worldwide financial marketplace by secretly manipulating LIBOR.[7] The conduct is appalling. It was a complete criminal fraud upon the worldwide marketplace.

Prior Commissions sensibly did not grant WKSI waivers for criminal misconduct. At least, that was the practice until September 19, 2013, when Commission staff granted a waiver to a large institution that pleaded guilty to criminal fraud.[8] This Commission granted another waiver on April 25, 2014, to another large institution that had also been criminally convicted of manipulating LIBOR.[9] A majority of this Commission, with this current action, continues the trend by granting its third waiver for criminal conduct at a large institution in a little less than two years. It is safe to assume that these waiver requests will continue to roll in, as issuers are now emboldened by an unofficial Commission policy to overlook widespread and serious criminal conduct — and ensure that the largest companies retain their array of advantages in our capital markets.

It is unclear to me how this waiver can be granted, for reasons substantially similar to those I outlined in my dissent regarding another institution involved in LIBOR manipulation.[10] Among other factors, the egregious criminal nature of the conduct and the duration of the manipulation (almost a decade) weigh heavily in my mind when considering this waiver. Additionally, Deutsche Bank is a recidivist, and its past conduct undermines its current promise of future good conduct. Since 2004, Deutsche Bank has, among other violations, a criminal admission of wrongdoing connected to promoting tax shelters,[11] a settlement involving misleading investors about auction rate securities,[12] and a violation against its investment bank for improperly asserting influence over research analysts.[13] Deutsche Bank requested and was previously granted a WKSI waiver in 2007 and 2009.

This criminal scheme involving LIBOR manipulation was designed to inflate profits, and it was effective. It created the impression that Deutsche Bank was more creditworthy and profitable than it actually was. Accordingly, the conduct affected its financial results and disclosures. Because LIBOR plays such an important role in the worldwide economy, manipulation of it goes to the heart of many aspects of Deutsche Bank’s disclosures. Interest rates represented to clients and the public also were clearly false. Based on this conduct, I do not find any basis to support the assertion that Deutsche Bank’s culture of compliance is dependable, or that its future disclosures will be accurate and reliable.

Finally, Deutsche Bank has not shown good cause for receiving a waiver from automatic disqualification, in this, its third WKSI waiver request in eight years. I am unable to conclude that Deutsche Bank’s culture of compliance and the reliability and accuracy of its future disclosures establishes good cause for a waiver. As the U.S. Commodity Futures Trading Commission’s (“CFTC”) Director of Enforcement noted: “Deutsche Bank’s culture allowed such egregious and pervasive misconduct to thrive.”[14]

For all of these reasons, I cannot support the Commission’s latest waiver.

In addition, the Commission adopted rules disqualifying felons and other “Bad Actors” from Rule 506[15] offerings on July 10, 2013.[16] Based on the criminal conduct in this case, I expected to receive a request from Deutsche Bank AG for a waiver from the automatic disqualification contained in Rule 506.[17] After all, the final CFTC order was “based on a violation of any law that prohibits fraudulent, manipulative, or deceptive conduct.”[18] It should therefore trigger an automatic disqualification absent a waiver.

However, based on a loophole contained in Rule 506(d)(2)(iii), the CFTC has intervened and prevented the bad actor disqualification question from even coming before the Securities and Exchange Commission. The CFTC saw fit to opine on the SEC’s Rule 506 jurisprudence about whether Deutsche Bank AG should receive a waiver from automatic disqualification under SEC rules. It is unclear to me what, if any, analysis went into this decision and what prompted the CFTC to insert language into its final order stating that a bad actor disqualification “should not arise as a consequence of this Order.”[19] The implications of the CFTC’s actions here — and in other actions[20] — are deeply troubling. The Commission should closely review this provision and how it is being used.


[1] In the Matter of Deutsche Bank AG, Order under Rule 405 of the Securities Act of 1933, Granting a Waiver from Being an Ineligible Issuer, available at http://www.sec.gov/rules/other/2015/33-9764.pdf.

[2] For more information on the statements of facts, plea agreement, and deferred prosecution agreement related to the LIBOR manipulation, see “Deutsche Bank's London Subsidiary Agrees to Plead Guilty in Connection with Long-Running Manipulation of LIBOR,” available at http://www.justice.gov/opa/pr/deutsche-banks-london-subsidiary-agrees-plead-guilty-connection-long-running-manipulation.

[3] See Division of Corporation Finance’s Revised Statement on Well-Known Seasoned Issuer Waivers (Apr. 24, 2014), available at http://www.sec.gov/divisions/corpfin/guidance/wksi-waivers-interp-031214.htm.

[4] Id.

[5] See Rule 405 of the Securities Act of 1933 (the “Securities Act”) (17 C.F.R. 230.405).

[6] A review of WKSI waivers granted since August 2013, reveals a total of 12 such waivers granted, 100% of which went to large financial institutions. See Division of Corporation Finance, available at http://www.sec.gov/divisions/corpfin/cf-noaction.shtml#405. This is precisely the concern I expressed a year ago in a dissenting statement from another waiver. See Dissenting Statement In the Matter of Royal Bank of Scotland Group, plc, Regarding Order Under Rule 405 of the Securities Act of 1933, Granter a Waiver from Being an Ineligible Issuer (Apr. 28, 2014), available at http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541670244 (“I fear that the Commission’s action to waive our own automatic disqualification provisions arising from RBS’s criminal misconduct may have enshrined a new policy—that some firms are just too big to bar.”).

[7] See Deutsche Bank Services (UK) Ltd. Statement of Facts, available at http://www.justice.gov/sites/default/files/opa/press-releases/attachments/2015/04/23/dbgs_statement_of_facts.pdf. Numerous Deutsche Bank derivatives traders communicated their desire to manipulate LIBOR to Deutsche Bank pool and money market derivatives traders, causing the pool and money market derivatives traders to submit false and misleading LIBOR contributions. These derivatives traders would then enter into derivatives transactions tied to LIBOR with unsuspecting counterparties who were unaware of Deutsche Bank’s criminal manipulation of LIBOR going on behind the scenes. These counterparties included universities, charitable organizations, and other financial institutions.

[8] See Letter from the Division of Corporation Finance to Mr. Steven Slutzky (Sep. 19, 2013) available at http://www.sec.gov/divisions/corpfin/cf-noaction/2013/ubs-ag-091913-405.pdf regarding “UBS-AG — Waiver Request of Ineligible Issuer Status under Rule 405 of the Securities Act.”

[9] See Order Under Rule 405 of the Securities Act of 1933, Granting a Waiver From Being an Ineligible Issuer, In the Matter of Royal Bank of Scotland Group, plc, Rel. No. 33-9578, (Apr. 25, 2014) available at http://www.sec.gov/rules/other/2014/33-9578.pdf.

[10]See Dissenting Statement In the Matter of Royal Bank of Scotland Group, plc, Regarding Order Under Rule 405 of the Securities Act of 1933, Granter a Waiver from Being an Ineligible Issuer (Apr. 28, 2014), available at http://www.sec.gov/News/PublicStmt/Detail/PublicStmt/1370541670244.

[11] See “Deutsche Bank to Pay More Than $550 Million to Resolve Federal Tax Shelter Fraud Investigation,” available at http://www.justice.gov/sites/default/files/tax/legacy/2011/01/03/deutschebankpr.pdf.

[12] See “SEC Finalizes ARS Settlements With Bank of America, RBC and Deutsche Bank, Providing Over $6 Billion in Liquidity to Investors,” available at https://www.sec.gov/litigation/litreleases/2009/lr21066.htm.

[13] See “SEC Sues Deutsche Bank Securities Inc. for Research Analyst Conflicts of Interest and Failure to Timely Produce All E-Mail,” available at https://www.sec.gov/litigation/litreleases/lr18854.htm.

[14] U.S. Commodity Futures Trading Commission, Press Release “Deutsche Bank to Pay $800 Million Penalty to Settle CFTC Charges of Manipulation, Attempted Manipulation, and False Reporting of LIBOR and Euribor,” (Apr. 23, 2015), available at http://www.cftc.gov/PressRoom/PressReleases/pr7159-15.

[15] Rule 506 of Regulation D is considered a safe harbor for the private offering exemption of Section 4(a)(2) of the Securities Act. (17 C.F.R. 230.506).

[16] Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“the Dodd-Frank Act”) required the Commission to adopt rules that disqualify certain securities offerings from reliance on Rule 506 of Regulation D. See Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings, Release No. 33-9414 (July 10, 2013), available at http://www.sec.gov/rules/final/2013/33-9414.pdf.

[17] See Rule 506(d)(1)(iii) of the Securities Act of 1933. (17 C.F.R. 230.506(d)(1)(iii)).

[18] See id.

[19] In the Matter of Deutsche Bank AG, CFTC Docket No. 15-20, at 44 (Apr. 23, 2015), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfdeutscheorder042315.pdf.

[20] See, e.g., In the Matter of JPMorgan Chase Bank, NA, CFTC Docket No. 14-01, at 18 (Oct. 13, 2013), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfjpmorganorder101613.pdf; CFTC v. Royal Bank of Canada, 13 Civ 2497, at 14 (Dec. 18, 2014), available at http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfrbcorder121814.pdf.

DOJ ANNOUNCES INDICTMENTS IN ALLEGED LIBOR INTEREST RATE MARKET MANIPULATION CASE

FROM:  U.S. JUSTICE DEPARTMENT 

THURSDAY, OCTOBER 16, 2014

TWO FORMER RABOBANK TRADERS INDICTED FOR ALLEGED

MANIPULATION OF U.S. DOLLAR, YEN LIBOR INTEREST RATES

Six Individuals Now Charged in Rabobank LIBOR Investigation

WASHINGTON — Two former Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A. (Rabobank) derivative traders – including the bank’s former Global Head of Liquidity & Finance in London – have been charged in a superseding indictment for their alleged roles in a scheme to manipulate the U.S. Dollar (USD) and Yen London InterBank Offered Rate (LIBOR), a benchmark interest rate to which trillions of dollars in interest rate contracts were tied, the Justice Department announced today.  Six former Rabobank employees have now been charged in the Rabobank LIBOR investigation.

Assistant Attorney General Leslie R. Caldwell of the Justice Department’s Criminal Division, Deputy Assistant Attorney General Brent Snyder of the Justice Department’s Antitrust Division and Assistant Director in Charge Andrew G. McCabe of the FBI’s Washington Field Office made the announcement.

Earlier today, a federal grand jury in the Southern District of New York returned a superseding indictment charging Anthony Allen, 43, of Hertsfordshire, England; and Anthony Conti, 45, of Essex, England, with conspiracy to commit wire fraud and bank fraud and with substantive counts of wire fraud for their participation in a scheme to manipulate the USD and Yen LIBOR rate in a manner that benefitted their own or Rabobank’s  financial positions in derivatives that were linked to those benchmarks.

The indictment also charges Tetsuya Motomura, 42, of Tokyo, Japan, and Paul Thompson, 48, of Dalkeith, Australia, who were charged in a prior indictment with Paul Robson, a former Rabobank LIBOR submitter.  In addition to adding as defendants Allen and Conti, the superseding indictment alleges a broader conspiracy to manipulate both the USD LIBOR and the Yen LIBOR.

Robson and Takayuki Yagami, a former Rabobank derivatives trader, each pleaded guilty earlier this year to one count of conspiracy in connection with their roles in the scheme.

“Today, we have charged two more members of the financial industry with influencing Dollar LIBOR and Yen LIBOR to gain an illegal advantage in the market, unfairly benefitting their own trading positions in financial derivatives,” said Assistant Attorney General Caldwell.  “LIBOR is a key benchmark interest rate that is relied upon to be free of bias and self-dealing, but the conduct of these traders was as galling as it was greedy.  Today’s charges are just the latest installment in the Justice Department’s industry-wide investigation of financial institutions and individuals who manipulated global financial rates.”

“With today’s charges against Messrs. Allen and Conti, we continue to reinforce our message to the financial community that we will not allow the individuals who perpetrate these crimes to hide behind corporate walls,” said Deputy Assistant Attorney General Snyder.  “This superseding indictment, with its charges against Mr. Allen, makes an especially strong statement to managers in financial institutions who devise schemes to undermine fair and open markets but leave the implementation – and often the blame – with their subordinates.”

“With today’s indictments the FBI’s investigation into Rabobank’s manipulation of LIBOR benchmark rates expands in scope to include the U.S. Dollar,” said Assistant Director in Charge McCabe. “I would like to thank the special agents, forensic accountants, and analysts, as well as the prosecutors who have worked to identify and stop those who hide behind complex corporate and securities fraud schemes.”

According to the superseding indictment, at the time relevant to the charges, LIBOR was an average interest rate, calculated based on submissions from leading banks around the world, reflecting the rates those banks believed they would be charged if borrowing from other banks.   LIBOR was published by the British Bankers’ Association (BBA), a trade association based in London.  LIBOR was calculated for 10 currencies at 15 borrowing periods, known as maturities, ranging from overnight to one year.  The published LIBOR “fix” for U.S. Dollar and Yen currency for a specific maturity was the result of a calculation based upon submissions from a panel of 16 banks, including Rabobank.

LIBOR serves as the primary benchmark for short-term interest rates globally and is used as a reference rate for many interest rate contracts, mortgages, credit cards, student loans and other consumer lending products.

Rabobank entered into a deferred prosecution agreement with the Department of Justice on Oct. 29, 2013, and agreed to pay a $325 million penalty to resolve violations arising from Rabobank’s LIBOR submissions.

According to allegations in the superseding indictment, Allen, who was Rabobank’s Global Head of Liquidity & Finance and the manager of the company’s money market desk in London, put in place a system in which Rabobank employees who traded in derivative products linked to USD and Yen LIBOR regularly communicated their trading positions to Rabobank’s LIBOR submitters, who submitted Rabobank’s LIBOR contributions to the BBA.  Motomura, Thompson, Yagami and other traders entered into derivative contracts containing USD or Yen LIBOR as a price component and they asked Conti, Robson, Allen and others to submit LIBOR contributions consistent with the traders’ or the bank’s financial interests, to benefit the traders’ or the banks’ trading positions.  Conti, who was based in London and Utrecht, Netherlands, served as Rabobank’s primary USD LIBOR submitter and at times acted as Rabobank’s back-up Yen LIBOR submitter.  Robson, who was based in London, served as Rabobank’s primary submitter of Yen LIBOR.  Allen, in addition to supervising the desk in London and money market trading worldwide, occasionally acted as Rabobank’s backup USD and Yen LIBOR submitter.  Allen also served on a BBA Steering Committee that provided the BBA with advice on the calculation of LIBOR as well as recommendations concerning which financial institutions should sit on the LIBOR contributor panel.

The charges in the superseding indictment are merely accusations, and the defendants are presumed innocent unless and until proven guilty.

The investigation is being conducted by special agents, forensic accountants and intelligence analysts in the FBI’s Washington Field Office.  The prosecution is being handled by Senior Litigation Counsel Carol L. Sipperly and Trial Attorney Brian R. Young of the Criminal Division’s Fraud Section and Trial Attorney Michael T. Koenig of the Antitrust Division.  The Criminal Division’s Office of International Affairs has provided assistance in this matter.

The Justice Department expresses its appreciation for the assistance provided by various enforcement agencies in the United States and abroad.  The Commodity Futures Trading Commission’s Division of Enforcement referred this matter to the department and, along with the U.K. Financial Conduct Authority, has played a major role in the LIBOR investigation.  The Securities and Exchange Commission also has played a significant role in the LIBOR series of investigations, and the department expresses its appreciation to the United Kingdom’s Serious Fraud Office for its assistance and ongoing cooperation. The department has worked closely with the Dutch Public Prosecution Service and the Dutch Central Bank in the investigation of Rabobank.  Various agencies and enforcement authorities from other nations are also participating in different aspects of the broader investigation relating to LIBOR and other benchmark rates, and the department is grateful for their cooperation and assistance.

This prosecution is part of efforts underway by President Barack Obama’s Financial Fraud Enforcement Task Force.  President Obama established the interagency Financial Fraud Enforcement Task Force to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes.  The task force includes representatives from a broad range of federal agencies, regulatory authorities, inspectors general and state and local law enforcement who, working together, bring to bear a powerful array of criminal and civil enforcement resources.  The task force is working to improve efforts across the federal executive branch, and with state and local partners, to investigate and prosecute significant financial crimes, ensure just and effective punishment for those who perpetrate financial crimes, combat discrimination in the lending and financial markets and recover proceeds for victims of financial crimes.  For more information about the task force visit: www.stopfraud.com.

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14-1134

CHAIRMAN CFTC SPEAKS TO FINANCIAL STABILITY OVERSIGHT COUNCIL

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
 
Statement of Chairman Gary Gensler Before the Financial Stability Oversight Council

April 25, 2013
I support the Financial Stability Oversight Council’s (FSOC) annual report and the recommendations. I want thank the FSOC members and their staffs for their work on this year’s important report and capturing the vulnerability to our financial system in its seven themes. I appreciate and wish to compliment their dedication to and coordination on financial reform.

Congress asked us to make recommendations once a year to enhance the integrity, efficiency, competitiveness and stability of U.S. financial markets.

In addition, we are to make recommendations to promote market discipline and maintain investor confidence. In that regard, the report recommends reforms of wholesale funding markets; housing finance; reference rates, such as LIBOR and similar interest rate benchmarks; and heightened risk management and supervisory attention.

Further, the FSOC agencies have made great progress on financial reform since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Working with FSOC agencies, the CFTC has completed most of the Title VII swaps market reforms on transparency, clearing and oversight of swap dealers. The market is increasingly moving to implementation of these common-sense rules of the road.

There are two critical areas, however, in which the CFTC must complete reforms.

First, it is a priority to finish rules to promote pre-trade transparency, including those for swap execution facilities and the block rule for swaps.

Second, it’s a priority that the Commission, working with domestic and international regulators, complete guidance on the cross-border application of swaps market reform.

CFTC CHAIRMAN GARY GENSLER COMMENTS ON LIBOR

FROM: COMMODITY FUTURES TRADING COMMISSION
Remarks of Chairman Gary Gensler on Libor before the Global Financial Markets Association’s Future of Global Benchmarks Conference
February 28, 2013

Good morning. Thank you, Ken, for that kind introduction. I also want to thank the Global Financial Markets Association for the invitation to speak at your conference on the Future of Global Financial Benchmarks.

This conference comes at a critical juncture.

It comes as there has been a lot of media attention surrounding the three enforcement cases against Barclays, UBS and RBS for manipulative conduct with respect to the London Interbank Offered Rate (LIBOR) and other benchmark interest rate submissions.

More importantly, it comes as market participants and regulators around the globe have turned to consider the critical issue of how we reform and revise a system that has become so reliant on LIBOR and similar rates.

I believe that continuing to reference such rates diminishes market integrity and is unsustainable in the long run.

Let’s look at what we’ve learned to date.

First, the interbank, unsecured market to which LIBOR and other such rates reference has changed dramatically. Some say that it is has become essentially nonexistent. In 2008, Mervyn King, the governor of the Bank of England, said of LIBOR: "It is, in many ways, the rate at which banks do not lend to each other."

There has been a significant structural shift in how financial market participants finance their balance sheets and trading positions. There is an increasing shift from borrowing unsecured (without posting collateral) toward borrowings that are secured by posting collateral. In particular, this shift has occurred within the funding markets between banks.

The London interbank, unsecured market used to be where banks funded themselves at a wholesale rate. But the 2008 financial crisis and subsequent events have shattered this model.

The European debt crisis that began in 2010 and the downgrading of large banks’ credit ratings have exacerbated the hesitancy of banks to lend unsecured to one another.

Other factors have played a role in this structural shift. Central banks are providing significant funding directly to banks. Banks are more closely managing demands on their balance sheets. And looking forward, recent changes to Basel capital rules will take root and will move banks even further from interbank lending.

The Basel III capital rules now include an asset correlation factor, which requires additional capital when a bank is exposed to another bank. This was included in the new standards to reduce financial system interconnectedness.

Furthermore, the rules introduce provisions for a liquidity coverage ratio (LCR). For the first time, banks will have to hold a sufficient amount of high quality liquid assets to cover their projected net outflows over 30 days.

At a roundtable on financial market benchmarks held in London last week, one major bank indicated that the LCR rule alone would make it prohibitively expensive for banks to lend to each other in the interbank market for tenors greater than 30 days. Thus, this banker posited that it is unlikely that banks will return to the days when they would lend to each other for three months, six months or a year.

Second, we also have learned that LIBOR – central to borrowing, lending and hedging in our economy – has been readily and pervasively rigged.

Barclays, UBS and RBS were fined $2.5 billion for manipulative conduct by the CFTC, the UK Financial Services Authority (FSA) and the Justice Department. At each bank, the misconduct spanned many years, took place in offices in several cities around the globe, included numerous people – sometimes dozens, even included senior management, and involved multiple benchmark rates and currencies. In each case, there was evidence of collusion.

In the UBS and RBS cases, one or more inter-dealer brokers painted false pictures to influence submissions of other banks, i.e., to spread the falsehoods more widely. Barclays and UBS also were reporting falsely low borrowing rates in an effort to protect their reputation.

These findings are shocking, though the lack of an interbank market made the system more vulnerable to such misconduct.

Third, we have seen a significant amount of publicly available market data that raises questions about the integrity of LIBOR today.

A comparison of LIBOR submissions to the volatilities of other short-term rates reflects that LIBOR is remarkably much more stable than any comparable rate. For instance, how is it that in 2012 – if we look at the 252 submission days for three-month U.S. dollar LIBOR – the banks didn’t change their rate 85 percent of the time?

Why is it that some banks didn’t change their submissions for three-month U.S. Dollar LIBOR for upwards of 115 straight trading days? This means that one bank said the market for its funding was completely stable for 115 straight trading days or more than five months.

When comparing LIBOR submissions to the same banks’ credit default swaps spreads or to the broader markets’ currency forward rates, why is there a continuing gap between LIBOR and what those other market rates tell us?

In the fall of 2011, there was so much uncertainty in markets due to the European debt crisis and challenges here in the United States. How is it that a number of the banks were still saying they could borrow in the interbank market for one year at about 1 percent, even though the traded markets for the same institutions’ one-year credit default swaps were trading four or five times higher?

Further, there’s a well-known concept in finance called interest rate parity, basically that currency forward rates will align with interest rates in two different economies. Why is it that since the financial crisis, that has not been the case, whether looking at the dollar versus the euro, sterling or yen? Theory hasn’t been aligning with practice. The borrowing rate implied in the currency markets is quite different than LIBOR.

Nassim Nicholas Taleb, whom you may know as the bestselling author of The Black Swan, has written a recent book called Antifragile: Things that Gain from Disorder. His main theme is: "Just as human bones get stronger when subjected to stress and tension … many things in life benefit from stress, disorder, volatility, and turmoil."

He notes that systems that are fragile succumb to stress, tension and change. Systems that are not readily able to evolve and adapt are fragile.

One of his main points is that propping up a fragile system in the interest of maintaining a sense of stability only creates more instability in the end. One can buy an artificial sense of calm for a while, but when that calm cracks, the resulting turmoil is invariably greater.

I think that the financial system’s reliance on interest rate benchmarks, such as LIBOR and Euribor, is particularly fragile.

These benchmarks basically haven’t adapted to the significant changes in the market. The interbank, unsecured lending market, particularly for longer tenors, is essentially nonexistent. LIBOR and similar benchmarks have been readily and pervasively rigged. And there is substantial market data that raises questions about LIBOR’s continuing integrity.

Thus, the challenge we face is how does the financial system adapt to this significant shift?

At the London roundtable on financial market benchmarks held last week, a man approached me to discuss a bit of the history of LIBOR in which he had personally been involved. It seems that in 1970, as a young banker, he worked on a floating rate note deal for ENEL issued by Bankers Trust that used a reference rate called LIBOR.

A lot has changed since 1970 – Nixon was President, we were in the midst of the Vietnam War, the Beatles released their final album Let It Be, and I was a kid wearing bell-bottoms.

Sixteen years later, the British Bankers Association (BBA) began publishing LIBOR as we know it today. A lot has changed since 1986 – Reagan was President, we were in the midst of the Cold War, and I was dating the wonderful woman I would marry, Francesca.

And now, I have three wonderful daughters but am a single dad. In life, one must adapt to change.

Yet LIBOR – embedded in the wiring of our financial system – largely remains the same.

This is why international regulators and market participants have begun to discuss transition. The CFTC and the FSA are co-chairing the International Organization of Securities Commissions (IOSCO) Task Force on financial market benchmarks. The task force is developing international principles for benchmarks and examining best mechanisms or protocols for a benchmark transition, if needed.

In January, the task force published the Consultation Report on Financial Benchmarks, and a final report will be published this spring.

One of the key questions in the consultation is how do we address transition when a benchmark is no longer tied to sufficient transactions and may have become unreliable or obsolete?

The consultation seeks public input about transition in two contexts:

• Prospectively, the consultation suggests that contracts referencing a benchmark would be more resilient if those contracts had embedded in them a contingency plan for when a benchmark may become obsolete.

• And perhaps more challenging, the consultation asks what to do about existing contracts that reference a benchmark that becomes obsolete, if those contracts don’t have an effective contingency plan.

Martin Wheatley of the FSA recommended that Canadian dollar LIBOR and Australian dollar LIBOR cease to exist so a transition is necessary, at least for those reference rates.

The market has some experience with transition, albeit for smaller contracts, such as for energy and shipping rate benchmarks. The basic components of such a transition include identifying a new and reliable benchmark, one that is anchored in transactions. The new and existing benchmarks run in parallel for a period of time to allow market participants to transition.

A critical statement in the consultation report was: "The Task Force is of the view that a benchmark should as a matter of priority be anchored by observable transactions entered into at arm’s length between buyers and sellers in order for it to function as a credible indicator of prices, rates or index values."

It went on to say: "However, at some point, an insufficient level of actual transaction data raises concerns as to whether the benchmark continues to reflect prices or rates that have been formed by the competitive forces of supply and demand."

I agree with both of these statements. A reference rate has to be based on facts, not fiction.

Without transactions, the situation is similar to trying to buy a house, when your realtor can’t give you comparable transaction prices in the neighborhood – because no houses were sold in the neighborhood in years.

Given what we know now, it’s critical that we move to a more robust framework for financial benchmarks, particularly those for short-term, variable interest rates. There are alternatives that market participants are considering that are grounded in real transactions. These include the overnight index swaps rate, benchmark rates based on actual short-term collateralized financings, and benchmarks based on government borrowing rates.

There are important ongoing international efforts to come up with principles for financial market benchmarks. These principles will address governance, conflicts of interest and transparency of reporting.

Nevertheless, even if we’re able to address these issues, there remains the issue of whether LIBOR and similar rates continue to reference an underlying market that is essentially nonexistent.

I recognize that moving on from LIBOR may be challenging. Today, LIBOR is the reference rate for 70 percent of the U.S. futures market, most of the swaps market and nearly half of U.S. adjustable rate mortgages.

I recognize that moving on from LIBOR may be unpopular. But as the author Nassim Taleb might suggest, it would be best not to fall prey to accepting that LIBOR or any benchmark is "too big to replace."

I believe that the best way to promote both market integrity and long-term stability is by ensuring that benchmarks are reliable and honest. And I believe it’s critical to work together to promote a smooth transition, where needed.

I recognize that change can be hard, but change is also a natural part of life.

After all, I’m sure you’re relieved I didn’t show up in bell-bottoms today.