Tuesday, 28 August 2012

Low balling the LIBOR – the LIBOR rate-rigging scandal

This article first appeared in the CCH Australian Competition & Consumer Law Tracker, Issue 8, August 2012.

The LIBOR scandal appears to be gaining momentum. Each week we are gaining more insights into the likely scale and scope of the LIBOR rate rigging scandal.  Most recently, there have been reports that the Antitrust Division of the US Department of Justice has offered several former UBS AG employees immunity from criminal prosecution in return for their cooperation in the investigation of suspected LIBOR rate manipulation.[1] The UK Serious Fraud Office has also been quite vocal about its ability to prosecute and jail any banking executives who can be proven to have been involved in the LIBOR rate rigging.[2] In addition, many of the banks at the centre of the allegations have been conducting their own internal investigations and have started dismissing employees who they have found to be involved in rigging the LIBOR.   

In this article, I will be seeking to provide a summary of the relevant background to the LIBOR scandal and then outlining the rapid developments which have been occurring over the last month since Barclay’s settlement with US and US regulators.  Finally, I will be briefly discussing the level of penalties and civil damages which the alleged cartel members may ultimately have to pay to regulators and to the victims of the cartel.

What is the LIBOR?
The LIBOR (or London Interbank Offered Rate) is the main reference point for calculating global short-term interest rates. As explained by Abrantes-Metz:

The LIBOR has been called “world's most important number”.  It is a primary benchmark for global short-term interest rates; the LIBOR is used as a basis for the settlement of interest rate contracts on many of the world's major futures and options exchanges as well most over-the-counter and lending transactions with an estimated value of U.S. $350-400 trillion contracts, instruments and transactions referencing it.[3]

The LIBOR was calculated by the British Bank Association (BBA) in the following way - each day the BBA would ask 16 of the worlds leading banks the following question:

At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11am London time?

The BBA would then take the quotes from the 16 participating banks and determine the four highest and the four lowest quotes.  It would then disregard these eight quotes and then work out the average of the remaining eight “middle” quotes. This average figure would become the LIBOR rate, which would then become the reference for trillions of dollars of contracts, instruments and other transactions.

The 16 participating banks at the time when the alleged LIBOR scandal was to said to have occurred were:

·       Bank of Tokyo–Mitsubishi UFJ
·       Bank of America
·       Barclays bank
·       JP Morgan Chase
·       Citigroup
·       Credit Swisse First Boston (CSFB)
·       Deutsche Bank
·       HBOS
·       HSBC
·       Lloyds
·       Norinchukin
·       Rabobank
·       Royal Bank of Canada
·       Royal Bank of Scotland
·       UBS AG
·       West LB

First warnings
The first warnings that there may be something wrong with the LIBOR rate arose in May 2008.  In an article written for the Wall Street Journal, Carrick Mollenkamp and Mark Whitehouse argued that a number of the participating banks may have filed flawed interest rate data in order to reduce their own borrowing costs.[4]  As stated in the article:

The Journal analysis indicates that Citigroup, WestLB, HBOS, JP Morgan Chase & Co and UBS are among the banks that have been reporting significantly lower borrowing costs for the London interbank offered rate, or LIBOR, than what other market measures suggest they should be.[5]

The market measure which Mollenkamp and Whitehouse were referring to was the market for credits–default swaps, or the default insurance market.  Such credit-default insurance is generally seen as a good indicator of a bank's financial health because it measures the likelihood of a bank reneging on its debts. 

Accordingly, Mollenkamp and Whitehouse formed the view that if the LIBOR rates were accurate, that they should be moving in unison with the credit-default swap market. However, after “crunching the numbers” Mollenkamp and Whitehouse concluded that:

… beginning in late January (2008), as fears grew about possible bank failures, the two measures began to divert, with reported LIBOR failing to reflect rising default – insurance costs… The gap between the two measures was wider for Citigroup, Germany's WestLB, UK’s HBOS, JP Morgan Chase and Switzerland’s UBS than for the other 11 banks. One possible explanation for the gap is that banks understated their borrowing rates.[6]

Mollenkamp and Whitehouse also speculated about the potential effects of the participating banks “low-balling” the LIBOR. If the LIBOR had been understated to the extent estimated by Mollenkamp and Whitehouse, this would have resulted $45 billion less interest being paid by borrowers, which would have included the participating banks.

Mollenkamp and Whitehouse also provided details of a particularly graphic example involving UBS AG, which appeared to support their broader thesis.  In April 2008, UBS AG went to the commercial-paper market to borrow dollars for a three-month period at an annual interest rate of 2.85%. However, the interest rate that UBS AG submitted to the BBA as part of its LIBOR quote for 16 August 2008, was only 2.73%, which was 0.12% lower than the interest rate at which it was actually borrowing money.

Muddying the waters
After the Mollenkamp and Whitehouse article, a number of economists took up the challenge of trying to establish whether the LIBOR rate had in fact been manipulated.

In an article written in August 2008, entitled LIBOR Manipulation?, Rosa M Abrantes-Metz, Michael Kraten, Albert D Metz and Gim Seow,[7] set out to examine the methodology adopted by Mollenkamp and Whitehouse to determine whether the LIBOR had been manipulated.   In their analysis, the authors also sought to compare the LIBOR rates with other rates of short-term borrowing costs, namely credit default swaps. 

After reviewing a considerable amount of data, the authors concluded:

While there are some apparent anomalies within the individual quotes, the evidence found is inconsistent with an effective manipulation of the level of the LIBOR.  However, some questionable patterns exist with respect to the bank’s daily LIBOR quotes, especially for the period ended August 8, 2007, for which the  intraday variance for banks quotes is not statistically different from zero.[8]

The conclusions reached by Abrantes-Metz et. al. were challenged by Snider and Youle in an article entitled Does the LIBOR reflect banks’ borrowing costs? written in 2010.  These authors also examined the banks’ LIBOR bids and compared then to observable cost measures, including both credit-default swap spreads and LIBOR quotes by the same banks for other currencies.  These authors concluded that:

…we have presented new evidence corroborating concerns that LIBOR panel banks maybe understating their true borrowing costs. Previous analysis of the problem have suggested the cause of this misreporting is the desire of panel banks to appear strong, especially during the recent banking crisis. In contrast, our theory of misreporting incentives points to a more fundamental source, namely that bank portfolio exposure to the LIBOR give them incentives to push the rate in a direction favorable to these positions.[9]

In other words, not only did Snider and Youle find that participating banks had understated the LIBOR, but they concluded that the participating banks had done so for the purpose of favouring their own trading positions.

Barclays’ Capitulation
Any debate as to whether the participating banks had been engaged in widespread manipulation of the LIBOR was put to rest with Barclays Bank’s $US450 million settlement with various regulators in June 2012.

On 27 June 2012, Barclays agreed to settle a Financial Services Authority (FSA) investigation with the payment of a financial penalty of £59.5 million in accordance with section 206 of the UK Financial Services and Markets Act 2000.  This fine represented a 30% discount off the FSA’s proposed financial penalty of £85 million because of Barclay’s cooperation and agreement to settle the case.

At the same time, Barclays agreed to pay fines of $US200 million to the Commodity Futures Trading Commission (CFTC) and a further $US160 million to the US Department of Justice (US DOJ) for their role in manipulating the LIBOR.

The FSA in its decision found that:

Barclays acted inappropriately and breached Principle 5 on numerous occasions between January 2005 and July 2008 by making US dollar LIBOR and EURIBOR submissions which took into account requests made by its interest rate derivatives traders (“Derivatives Traders”).  At times these included requests made on behalf of derivatives traders at other banks.  The Derivatives Traders were motivated by profit and sought to benefit Barclays’ trading positions.[10]  

The FSA identified 257 instances of traders asking the Barclay’s staff responsible for submitting LIBOR quotes to alter these quotes to benefit their trading position. There was also evidence of similar requests being made to alter the quotes for the yen and euro equivalents of the LIBOR.

The following are some of the more colourful examples taken from the FSA Report of the types of “inappropriate” behaviour that was occurring at Barclays:

1.      On 5 February 2008, Trader B (a US dollar Derivatives Trader) stated in a telephone conversation with Manager B that Barclays’ Submitter was submitting “the highest LIBOR of anybody […] He’s like, I think this is where it should be.  I’m like, dude, you’re killing us”. 

         Manager B instructed Trader B to: “just tell him to keep it, to put it low”. 

         Trader B said that he had “begged” the Submitter to put in a low LIBOR submission.

         The Submitter had said he would “see what I can do”.[11]

2.      On Friday, 10 March 2006, two US dollar Derivatives Traders made email requests for a low three month US dollar LIBOR submission for the coming Monday:

         Trader C stated “We have an unbelievably large set on Monday (the IMM).  We need a really low 3m fix, it could potentially cost a fortune.  Would really appreciate any help.”

         Trader B explained “I really need a very very low 3m fixing on Monday – preferably we get kicked out.  We have about 80 yards [billion] fixing for the desk and each 0.1 [one basis point] lower in the fix is a huge help for us. So 4.90 or lower would be fantastic”.  Trader B also indicated his preference that Barclays would be kicked out of the average calculation.[12]

3.      On Monday, 13 March 2006, the following email exchange took place:

         Trader C:  “The big day [has] arrived… My NYK are screaming at me about an unchanged 3m LIBOR.  As always, any help wd be greatly appreciated.  What do you think you’ll go for 3m?” 

         Submitter:  “I am going 90 altho 91 is what I should be posting”.

         Trader C:  “[…] when I retire and write a book about this business  your name will be written in golden letters […]”.

         Submitter:  “I would prefer this [to] not be in any book!”[13] 

4.     Trader C requested low one month and three month US dollar LIBOR submissions at 10:52 am on 7 April 2006 (shortly before the submissions were due to be made):

         “If it’s not too late low 1m and 3m would be nice, but please feel free to say “no”...  Coffees will be coming your way either way, just to say thank you for your help in the past few weeks”. 

         A Submitter responded “Done…for you big boy”.[14]

As is apparent from the above examples, the Barclays employees did not appear to be making any effort to keep secret their illegal activities in suppressing the LIBOR rates. It is also clear from these extracts that Barclays often engaged in the conduct for the purpose of protecting or promoting their own trading positions.

Futhermore, requests for a reduction of the Barclay’s LIBOR quotes did not only come from Barclays traders. Often requests would be received from external traders:

5.      On 26 October 2006, an external trader made a request for a lower three month US dollar LIBOR submission.  The external trader stated in an email to Trader G at Barclays “If it comes in unchanged I’m a dead man”. 

         Trader G responded that he would “have a chat”. 

         Barclays’ submission on that day for three month US dollar LIBOR was half a basis point lower than the day before, rather than being unchanged. 

         The external trader thanked Trader G for Barclays’ LIBOR submission later that day: “Dude.  I owe you big time!  Come over one day after work and I’m opening a bottle of Bollinger”.[15]

Finally, the FSA Report provides a number of examples of Barclays employees seeking to influence LIBOR rates and EURIBOR rates of competing banks:

6.      From early October 2006, Barclays’ Derivatives Traders communicated with others in order to co-ordinate high one month EURIBOR submissions on 16 October 2006.  These communications included the following:

         Trader E made internal requests for high one month EURIBOR submissions to Barclays’ Submitters.

         Trader E discussed his requests with an external trader at Panel Bank 1 and made requests to external traders at Panel Banks 2 and 3

         The external trader at Panel Bank 1 informed Trader E he would also make a request to a trader at Panel Bank 4.[16]

7.      Trader E communicated with traders at Panel Banks 1, 2 and 6 in advance of the IMM date (International Monetary Market date). 

         For example on 12 February 2007, Trader E stated in an instant message with a trader at Panel Bank 6:

         “if you know how to keep a secret I’ll bring you in on it…we’re going to push the cash downwards on the imm day…if you breathe a word of this I’m not telling you anything else…I know my treasury’s firepower…which will push the cash downwards…please keep it to yourself otherwise it won’t work.”[17]

The evidence contained in the FSA report of trader’s behaviour in relation to the LIBOR is reminiscent of the type of behaviour engaged in by Enron’s energy traders.  It is quite apparent from these accounts that LIBOR manipulation and collusion was an every day occurrence at Barclays.  Indeed, it appears that such illegal conduct was treated very much like a joke within Barclays and with the external traders with whom Barclays dealt.

Dominos starting to fall
Following the explosive revelations documented in the FSA Report, the pressure on both the participating banks and various government regulators to do something increased dramatically.  The following is only a brief summary of the major events which have occurred since the Barclay’s settlement on 27 June 2012.

On 3 July 2012, Bob Diamond, the Chief Executive Officer of Barclays and Jerry del Missier, the Chief Operating Officer of Barclays resigned.

On 6 July 2012, the US Serious Fraud Office announced that it would be undertaking a criminal investigation into the LIBOR scandal.[18]

On 27 July 2012, Britain's Lloyds Banking Group announced that it had received subpoenas and requests for information as part of global probes into the LIBOR scandal.  

On the same day, there were reports that Rabobank had fired four employees between 2008 and 2011 over the manipulation of interbank lending rates.[19]

On 28 July 2012, there was increased media speculation that UK-based Royal Bank of Scotland Group Plc was likely to be the next major target of the FSA in relation to the LIBOR scandal.

On 30 July 2012, the first of what would become a deluge of class actions was commenced by New York lender, Baltimore Bank. The lender alleged that it had been defrauded of interest income because rates on loans tied to LIBOR were "artificially" depressed. In its suit it indicated that "tens, if not hundreds, of billions of dollars" of loans made or sold in the state of New York alone were affected by rigging the LIBOR.[20]

One 30 July 2012, FINMA, the Swiss market supervisory authority announced that it was questioning UBS AG and Credit Suisse as part of an investigation into possible LIBOR rate rigging.[21]

On 31 July 2012, Deutsche Bank announced that it had discovered that a "limited number" of staff had been involved in the LIBOR rate-rigging scandal. However, Deutsche Bank also claimed that its internal inquiry had cleared senior management of taking part in attempts to manipulate the rate.[22]

On 2 August 2012, Bank of America Corporation disclosed that it had received subpoenas from the US DOJ, CFTC and FSA, as part of their investigations into the LIBOR.[23]

On 3 August 2012, Royal Bank of Scotland announced that it had dismissed a number of traders and employees due to concerns that they had been involved in manipulating the LIBOR.[24]

On 5 August 2012, news reports claimed that UBS AG had dismissed about two dozen traders and managers following an internal investigation into the manipulation of the LIBOR.[25]

On 8 August 2012, Citigroup announced in a filing to the US Securities and Exchange Commission that it had received requests for information and documents from various U.S. and non-U.S. various law-enforcement agencies in relation to the LIBOR.[26]

Finally, on 8 August 2012, there were reports that the Antitrust Division of the DOJ had reached an agreement several former UBS AG employees not to pursue criminal charges against them in return for their cooperation in the investigation of suspected LIBOR rate manipulation.[27]

As is apparent from the short history outlined above, there has been a remarkable amount of activity in relation to the LIBOR scandal in the last month since the Barclays settlement was announced.  

Where to from here?
It seems apparent that the LIBOR investigations are likely to gain even greater momentum over the next few weeks as regulators around the world follow the US DOJ’s lead – namely, by offering immunity deals to the various employees and traders who were involved in the LIBOR rate rigging, who have been subsequently dismissed by their employers. 

The actions of the US DOJ in offering the former UBS AG employees immunities strongly suggests that the US DOJ will be targeting the senior managers of the participating banks in its investigations. It is likely that the US DOJ has formed the view that the senior managers of the participating banks must have known of the conduct of their employees in manipulating the LIBOR. Indeed, based on the FSA evidence concerning the events at Barclays it is hard to see how the senior managers of the participating banks could not have been aware of what was going on with their LIBOR quotes.

It also seems clear that both the US DOJ and the UK Serious Fraud Squad are minded to pursue criminal penalties and jail time against those senior managers of the participating banks, if they can prove that they have colluded in the setting of LIBOR rates.  Furthermore, based on the pace of the investigations thus far it seems possible that the first indictments for LIBOR rate collusion may be only a few weeks away.

Finally, given the importance of the LIBOR rate to global finance, it is inevitable that any fines which will be sought by regulators against the participating banks will be immense. If the financial penalties in the Barclay’s settlement are any guide, the total fines and penalties could well exceed $5 billion once all the participating banks have either settled or been prosecuted. If one adds the likely damages which will arise from the deluge of class actions which have been launched, or are still to be launched against the participating banks, the total financial impact of the cartel on the banks could be many times higher. Indeed one estimate of the potential exposure of the participating banks to civil damages alone has been put at $35 billion.[28] If these estimates prove to be correct, the LIBOR scandal will become the largest and most costly cartel case in the history of antitrust.

[1] Ex-UBS Traders Offered Deal by U.S. in Rate Probe, The Wall Street Journal, 8 August 2012 - http://online.wsj.com/article/SB10000872396390443517104577575513575819698.html?mod=googlenews_wsj

[2] LIBOR: Criminal offences are capable of covering conduct, Serious Fraud Office, dated 30 July 2012 - http://www.sfo.gov.uk/press-room/latest-press-releases/press-releases-2012/libor-criminal-offences-are-capable-of-covering-conduct.aspx

[3] Libor Manipulation?, Rosa M Abrantes-Metz, Michael Kraten, Albert D Metz and Gim Seow, Social Science Research Network, p. 2 - http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1201389
[4] Study casts doubt on key lending rate: Banks may have filed flawed interest data for Libor benchmark, Carrick Mollenkamp and Mark Whitehouse, The Wall Street Journal, dated 30 May, 2008 reprinted at  http://www.efinancialnews.com/story/2012-07-02/wsj-archives-libor-2008
[5] Ibid.
[6] Ibid.
[7] op. cit., note 3.
[8] Ibid., p. 2.
[9] Does the LIBOR reflect banks’ borrowing costs?, Connan Snider and Thomas Youle, p. 5 - at http://www.econ.umn.edu/~youle001/libor_4_01_10.pdf, p.
[10] Final Notice, Financial Services Authority, dated 27 June 2012, http://www.fsa.gov.uk/static/pubs/final/barclays-jun12.pdf
[11] Ibid., p. 11.
[12] Ibid., p. 12.
[13] Ibid., p. 12.
[14] Ibid., p. 13.
[15] Ibid., p. 19.
[16] Ibid., p. 20.
[17] Ibid., p. 21.

[18] LIBOR: SFO to investigate, Serious Fraud Office, dated 6 July 2012 - http://www.sfo.gov.uk/press-room/latest-press-releases/press-releases-2012/libor-sfo-to-investigate.aspx

[19] Rabobank fired 4 staff over Libor fixing: report, Reuters, 27 July 2012 - http://www.reuters.com/article/2012/07/27/us-libor-rabobank-dismisals-idUSBRE86Q07N20120727

[20] Baltimore takes lead in suit against banks over alleged Libor ma­nipu­la­tion, The Washington Post, dated 12 July 2012 - http://www.washingtonpost.com/business/economy/baltimore-takes-lead-in-suit-against-banks-over-alleged-libor-manipulation/2012/07/11/gJQAN3V7dW_story.html

[21] Swiss regulator quizzes Credit Suisse, UBS on Libor, Reuters, 30 July 2012 - http://www.reuters.com/article/2012/07/30/us-banking-libor-finma-idUSBRE86T11C20120730

[22] Libor scandal: Deutsche Bank admits some staff involved, BBC News, dated 31 July 2012 - http://www.bbc.co.uk/news/business-19066284

[23] BofA Says Libor Probe Draws U.S. Subpoenas on Submissions, Bloomberg Businessweek, 3 August 2012 - http://www.businessweek.com/news/2012-08-02/bofa-says-libor-probe-draws-u-dot-s-dot-subpoenas-on-submissions

[24] RBS confirms it sacked staff over Libor rigging scandal, Reuters, 3 August 2012 - http://uk.reuters.com/article/2012/08/03/uk-rbs-earnings-idUKBRE87207P20120803

[25] UBS Dismisses Traders And Managers Over Libor, Der Sonntag Says, Bloomberg, 5 August 2012 - http://www.bloomberg.com/news/2012-08-05/ubs-dismisses-traders-and-managers-over-libor-der-sonntag-says.html

[26] Citigroup Says State AGs Probe Benchmark Rates, Bloomberg, 4 August 2012 - http://www.bloomberg.com/news/2012-08-03/citigroup-says-rate-probe-spurs-legal-inquiries-to-bank-s-units.html

[27] op. cit., note 1.

[28] Libor Scandal May Cost Banks $35 Billion: Study, Huffington Post, 9 August 2012 - http://www.huffingtonpost.com/2012/07/17/libor-scandal-cost-banks_n_1680764.html

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