Tuesday, 3 December 2013

Running on Empty: Why is the ACCC running out of money?


At a recent Senate estimates hearing before the Economics Legislation Committee, Rod Sims, the current chair of the Australian Competition and Consumer Commission (ACCC) admitted that the organisation had run up significant operational losses over the last three years.[1] The earlier realisation that the ACCC was operating well beyond its means prompted the Coalition government to claim that the previous Labor government had allowed the ACCC to “run down” by providing it with inadequate funding.[2] The Business Council of Australia also weighed into the debate, claiming that the ACCC had increased its staffing levels significantly over the last decade at a rate which outstripped the rate of employment growth across the broader economy.[3]

Given the divergent views, it is somewhat difficult to work out where the truth lies in relation to the ACCC's funding. Either the ACCC has been failing to manage its finances responsibly or its activities have been significantly underfunded for some time, which has in turn undermined its ability to enforce its legislation. As with most issues, neither position is entirely correct. The reality is that whilst the ACCC does not receive sufficient funding to properly carry out its legislative responsibilities, it has also been operating in an inefficient manner which has seen it achieving suboptimal outcomes.

In this blog post, I will identify the main areas of over-expenditure within the ACCC and identify where inefficiencies exist. I will then make some proposals which may assist the ACCC in improving its financial performance in the future.


The total amounts by which the ACCC has overspent its budget over the last three financial years is quite remarkable. As outlined in its most recent Annual Report for the 2012 – 2013 financial year,[4] the ACCC has generated the following losses over the last three years:

  • 2012-2013 $25.9 million
  • 2011-2012 $26 million
  • 2010-2011 $9.3 million

These losses should be seen in the context of the ACCC's total funding, as follows:
  • 2012-2013 $150 million
  • 2011-2012 $151 million
  • 2010-2011 $141 million
Therefore, the amount by which the ACCC has overspent its budget over the last three financial years has increased from 6.5% of its total budget in 2010-2011 to approximately 17% of its total budget in the following two financial years.

In other words, over the last two years the ACCC has spent almost 20% more than the amount that it received from the Commonwealth Government to run its operations.


The ACCC provided the following explanation to the recent Economics Legislation Committee as to why it had overspent its budget by such large amounts over the last three years:

(The overspend was) largely a function of the fact that we have been asked to do more. The economy is growing, so we get more mergers and we get more activity on all our fronts. We are the competition regulator, the consumer regulator, the safety regulator, we do a lot of compliance work, we deal with mergers, authorizations…
One of the problems for us has been that we are about 60 per cent staffing and about 15 per cent legal funding. All the various across-the-board cuts that have occurred through the public sector, particularly in the efficiency dividends, have really eroded our funding base quite a lot. There is very little room to move. When you are 60 per cent staffing and then you have legal expenses and property expenses, there are very few expenses you can actually do something with.[5]
In other words, the main reason for the funding shortfall was because the ACCC has been given more functions than it had three years ago. The efficiency dividend required by the former Labor government also had a negative impact on the ACCC’s funding position.

The ACCC reiterated this view when responding to comments by the Business Council of Australia (BCA) about the ACCC’s staffing levels. In the BCA report entitled “Improving Australia's Regulatory System”, it stated that the ACCC’s staffing levels had increased from 540 staff in the 2001-2002 financial year to 876 in the 2011-2012 year. The BCA commented that the ACCC’s staffing levels had “outstripped the rate of employment growth across the broader economy during the same period.”

The ACCC’s response to the BCA was swift. The ACCC immediately issued a media release to defend its position:

The Business Council of Australia has today issued a report showing that the Australian Competition and Consumer Commission’s staffing has increased from 540 in 2001-2 to 876 in 2011–12, or 4.95% per annum (the current number of working full time equivalent staff is actually just over 800). It seeks to make a point about the growth in regulatory spending and staff numbers.
The ACCC’s growth over this period is associated with completely new functions and responsibilities, most assumed from state regulators and other bodies. Without these additional functions, the ACCC’s base line growth since 2001-2 has been 1.8% per annum.
The ACCC’s new functions and responsibilities in the past ten years include:

  • The establishment of the Australian Energy Regulator (2005) following CoAG agreement to create a national energy market regulator has seen the transition of gas and electricity regulatory and enforcement functions from state regulators to the AER over the past 8 years.
  • In 2007, the ACCC became responsible for the development, monitoring and enforcement of water market and charge rules in the Murray Darling Basin.
  • Under the Wheat Export Marketing Act 2008, the ACCC is responsible for monitoring compliance of port operators for bulk export wheat.
  • Following the completion of its Fuel inquiry in 2007, the ACCC was directed by the government to undertake monitoring of the prices, costs and profits of unleaded petrol in Australia.
  • The ACCC assumed responsibility for the regulation of the Hunter Valley rail line from IPART in 2011.
  • In 2009, the ACCC became Australia’s national product safety regulator.
While the underlying staff growth of 1.8% per annum is below real GDP growth, this staffing increase has had to accommodate increased roles in our core areas, such as the regulation of the NBN, the introduction of the Australian Consumer Law, the criminalisation of cartel conduct and carbon price claims, to name a few.

Indeed, in the ACCC’s core responsibilities, such as in enforcing competition law, the ACCC’s staffing has likely not increased at all since 2001-2 despite the greater size and complexity of the Australian economy.
While vigorous in its defence, the ACCC’s news release it entirely disingenuous. The ACCC’s response claims that it has acquired a wide range of additional functions since 2001, whilst making no mention of the significant functions which it has lost since the 2001-2002 financial year, most notably its education, monitoring and enforcement role in relation to the introduction of the GST.

The introduction of the GST in 2000 resulted in the ACCC gaining an extensive economy-wide role in providing information to businesses and consumers about the operation of the new tax, as well as a role in conducting extensive price monitoring and enforcement activities. Indeed the ACCC’s role in relation to the introduction of the GST was in many respects the largest and most challenging function which the ACCC has ever been required to undertake in its history.

Therefore, it is quite inaccurate for the ACCC to claim, as it has, that it was the range of new functions which is has gained since 2001-2002 which has lead to the steep rise in staff numbers by 62% over the period. Indeed, it is arguable that the loss of the GST function means that the ACCC now has a much less demanding role than it did in 2001.

Staffing levels

ACCC staffing levels have fluctuated over the last few years. In the 2009-2010 financial year, the ACCC had 756 budgeted staff positions but only 732 actual staff numbers. In other words, the ACCC had 24 less staff on its books than the amount for which it was receiving funding.

This situation changed quite dramatically in the next financial year when the number of budgeted positions rose from 756 to 778. Unfortunately, the actual number of staff employed at the ACCC also rose over the course of that year from 732 to 790. In other words, the ACCC hired 18 more staff than to could afford to pay, based on its budgeted numbers.

In the 2011-2012, the ACCC received funding for a record 813 staff members. This level of staff funding was only slightly above its actual staff numbers of 807 staff.

The significant reduction in budgeted staff positions occurred in the 2012-2013 financial year, when the ACCC only received funding for 745 staff, a reduction of 68 staff positions from the previous year. It also seems that the ACCC was unable to reduce its actual staff numbers significantly in response to this reduction in its staffing budget. Despite receiving funding for 68 less staff members in 2012-2013, the ACCC was only able to reduce its actual staff numbers by nine positions. In other words, the ACCC operated throughout the 2012-2013 financial year with 53 unfunded staff members. Needless to say, this is very poor public administration.

Interestingly, the recent suggestion that the ACCC had not been properly funded by the former Labor Government seems questionable given the level of staff funding provided to the ACCC in the current financial year. In the 2013-2014 financial year, the ACCC has received funding for 802 staff positions which is an increase of 56 positions from the previous year, and four more positions than the ACCC’s actual staff numbers in the previous year.

Management structure

One concerning aspect about the ACCC’s current management structure is that it appears to be remarkably top heavy. In other words, there appears to be a disproportionately large number of senior managers being paid large salaries, including significant performance pay.

For example, the ACCC currently operates with one Chief Executive Officer and two Deputy Chief Executive Officers who are all at the Band 3 Senior Executive Service level. It seems somewhat strange that an organization with only 800 employees would effectively need three CEO’s to manage the organization.

Indeed, there would be very few private companies with significantly larger workforces that would need to employ three CEO’s.

Highly paid staff

Another concern relates to the number of highly paid staff within the ACCC. In the ACCC’s most recent annual report, the ACCC listed a total of 54 staff that would be considered highly paid staff.[6] Of these 54 staff, 49 staff were being paid in excess of $180,000 per year. In other words, over 5% of all ACCC staff are being paid more than $180,000 a year.

The annual report also shows that 14 staff are receiving salaries of between $210,000 to $239,000 per year, whilst a further 11 staff are receiving salaries of between $240,000 to $269,000 per year.

It is also apparent that the ACCC’s Senior Executive Service are much more expensive than the above salary figures would suggest. In the ACCC’s annual report, it records the total remuneration paid to the ACCC Senior Executive Staff in the form of salary, annual leave accrued, performance pay, other allowances, superannuation and long service leave.[7] This table shows that the ACCC’s 54 SES employees cost the ACCC a total of $17,768,883 in 2013 which equates to $329,053 per employee.

This level of remuneration for the ACCC’s Senior Executive Service appears to be quite excessive, particularly given that the ACCC is a public sector organization.

Performance pay

The ACCC annual report also records the total amount of performance pay being paid to its staff.[8] It appears that total performance pay of $1,185,026 was paid to 86 staff members in 2013. This equates to an average performance pay of approximately $13,800 per staff member.

While this is less than the amount of performance pay paid to staff in 2011-2012 financial year, which was approximately $1.3 million, one has to question whether a public sector organisation should be paying almost $1 million worth of performance pay to its employees each year.


Another area which has experienced significant growth over the last three years is in relation to consultancy agreements. The ACCC disclosed in its annual report that in the 2012-2013 financial year it entered into 62 new external consultancy contracts worth a total of $4.4 million. This is in addition to 17 ongoing consultancy contracts which account for a further $4 million.[9]

Therefore, in the 2012-2013 financial year, the ACCC spent a total of $8.8 million, or approximately 6% of its total budget, on external consultancies.

The amount spent by the ACCC on consultancies in the 2012-2013 financial year was 22% higher than the amount it spent on external consultancies in the previous financial year (ie $7.2 million) and 30% more than it spent in the 2010-2011 financial year (ie $6.9 million).

One has to ask why the ACCC has to enter into so many external consultancies and why it is paying so much for these consultancies. Another important question is why have external consultancies increased by 30% in dollar terms over the last three years.

This trend is even more concerning in the light of the fact that the ACCC has access to a large and highly paid, and one would assume highly skilled, Senior Executive Service. The question is why the ACCC cannot apparently meet its need for specialist technical advice from amongst the ranks of its existing Senior Executive Service.

How can the ACCC improve its bottom line?

During the ACCC’s evidence at the recent Senate Estimates hearings, it claimed to have implemented a range of strategies to reduce its costs, including by:

  • offering voluntary redundancies;
  • reducing travel costs;
  • cutting back on newspaper subscriptions; and
  • reviewing its accommodation needs. 
However, these measures only offer piecemeal solutions to the ACCC’s financial crisis.

As suggested above, a significant cost is the ACCC's Senior Executive Service. Not only does the ACCC’s Senior Executive Service appear to be disproportionately large, comprising 54 staff members, but this select group of employees is very costly, costing the ACCC approximately $329,000 per employee per year.

The ACCC must conduct an urgent and in-depth review into the size and cost of its Senior Executive Service to determine whether it needs such a large Senior Executive Service and whether some of these employees are being paid too much.

The ACCC should also conduct an urgent review of its performance pay scheme. Such a review is particularly important when one analyses the ACCC’s performance in relation to major litigation over the last three years. Whilst there have been a number of notable successes, including the airline cartel cases and the Apple iPad case, there have been a number of quite spectacular and costly losses including:
  • Metcash – Franklins merger opposition;
  • Google sponsored links case;
  • ANZ price fixing case; and
  • Cement Australia section 46 case.
Simply put the ACCC’s recent performance in major litigation cannot justify the organisation continuing to pay such generous performance pay.

It would also be sensible for the ACCC to review its practices in terms of entering into external consultancies. The ACCC is relying too heavily on external consultants to provide the types of advice which the ACCC should be able to obtain from its own Senior Executive Service.

Other sources of inefficiency


As a practitioner who has regular interactions with the ACCC, as well as a former ACCC employee for 15 years, it is quite easy to identify areas where the ACCC is not operating efficiently.

For example, one area of inefficiency relates to the way in which the ACCC runs its litigation. The ACCC has a tendency to overstaff its litigation in relation to small and medium sized cases. While it is invariably the case that larger corporate respondents will retain large legal teams consisting of lawyers from the top tier legal firms to fight the ACCC, the same is not true of small and medium respondents. It is relation to these smaller respondents that the ACCC ends up incurring too much legal expense.

The ACCC will often retain two or even three senior lawyers from a top tier legal firm or the Australian Government Solicitor to work on even relatively small cases. For example, in a recent case, the ACCC had a legal team consisting of three senior lawyers from a top tier legal firm and a senior barrister. This was despite the respondents only being represented by a small firm solicitor and a junior barrister.

The ACCC also appears to have developed a practice of overspending on barristers when running smaller cases. Often the ACCC will retain a senior barrister, or even a senior and a junior barrister when running relatively small and simple cases against unsophisticated opposition.

I recall that when I worked at the ACCC, we would often use a sole junior barrister on smaller cases to save money, as well as to skill-up these junior barristers. For example, we decided to use only a junior barrister in the high profile Ian Turpie impotency trial (namely Robert Bromwich, now the Commonwealth Director of Public Prosecutions). On another occasion, we decided to use a sole junior barrister to run a five-day trial in the Original Mama’s case. Both barristers rose to the challenge and did exceptionally well in each case.

The ACCC also have a habit to throwing enormous amounts of legal resources at large scale litigation in a haphazard way. This was particularly evident in a case I was involved in for a client who had agreed to give evidence as part of the ACCC's case. It was apparent to me from my interactions with the ACCC in that case that whilst it had assembled a very large legal team of experienced lawyers and barristers to run the case, there was also a total lack of organization and planning. Indeed, it seemed to me sometimes that the ACCC's legal team lacked any any clear case theory. Needless to say, the ACCC lost the case.

Companies in liquidation

Another area of concern relates to the ACCC’s tendency to continue pursuing litigation against companies which have gone into liquidation. I fail to see how a judgment or penalty against a company which no longer exists is a sensible use of the ACCC’s limited resources.

The ACCC will still have to spend a significant amount of money to secure a penalty and costs order against the company in liquidation. The only difference with these cases is that the ACCC knows beforehand that it will not recover any of the penalty or costs which may be ordered by the court.

For example each of the following cases, involved a company which had gone into liquidation:

  • Elite Publishing
  • E-Direct
  • Energy Watch 
  • Yellow Page Marketing BV/Yellow Publishing Limited
  • Global One Mobile Entertainment Ltd / 6G Pty Ltd
  • Marksun Australia Pty Ltd
  • · SMS Global
As far as I am aware, the ACCC never saw a cent of the penalties and costs awarded in these cases.

Case selection

While the ACCC’s case selection practices have improved dramatically over the last few years, there are still some notable anomalies.

For example, earlier this year the ACCC accepted an undertaking from Toyota Australia relation to representations that the upholstery in certain vehicle interiors was ‘leather’, when in fact the upholstery was only partially leather.[10]

I find it hard to understand why the ACCC pursued this matter, given that it seeks to prioritise matters based on the level of consumer detriment. If the ACCC had believed that Toyota’s conduct had created a significant degree of consumer detriment, one would have expected to see the ACCC demanding consumer remedies as part of the settlement.

However, the only remedies sought by the ACCC in relation to this matter were that Toyota: 

  • publish corrective notices;
  • implement a supplementary trade practices compliance program;
  • provide training for Toyota Australia sales and marketing staff and dealers; and 
  • implement a procedure for the review of product information materials.
In other words, there were absolutely no consumer remedies sought by the ACCC in this case.

Another odd use of resources relates to the Samsung Electronics case.[11] In this matter, Samsung provided an undertaking to the ACCC concerning alleged misrepresentations about the energy savings of its Bubble Wash washing machines compared to conventional washing machines. Despite the ACCC’s view that the company had misled its customers about these products, it did not require Samsung to offer any of its customers a refund of their purchase price. Rather, the only consumer remedy obtained by the ACCC in this case was that Samsung extend its manufacturer's warranty by three years.

I also represented a small Australian business in an ACCC investigation in relation to country of origin representations. The ACCC focused its investigation on the representations being made by my client in relation to products which it was exporting to places such as China, Korea and Europe.

Apart from the very real question of whether the ACCC even had jurisdiction in relation to this conduct, I could not see how the pursuit of this investigation was a justifiable use of the ACCC’s resources. After all, no Australian consumers were being affected by my client’s conduct.

The ACCC ultimately closed its investigation after a few months when it realized that my client was not breaching the Australian Consumer Law in relation to products it was selling to non-Australian consumers in overseas markets.

The treatment of legal costs

The indications are that the ACCC’s financial position will deteriorate further in the 2013-2014 financial year.

The ACCC will have to pay the legal costs orders made against it after losing two high profile and long running cases – namely the Google sponsored links case and the ANZ price fixing case. It is likely these two costs orders alone will be more than $5 million.

One change which the ACCC should propose to the current government relates to the way in which legal costs from litigation should be treated from an accounting perspective. As I understand current arrangements, the ACCC is required to pay any costs orders made against it out of its recurrent funding, whilst any costs orders made in the ACCC’s favour are paid into consolidated revenue, rather than into the ACCC’s accounts.

This approach to legal costs does not make any sense.

A more sensible approach would be to permit the ACCC to add any costs which it recovers in litigation to its recurrent budget. This would add significant revenues to the ACCC's overall budget, given its very high success rate in litigation.


The ACCC’s financial position has deteriorated significantly over the past three years, due primarily to the current Chairman’s ambitious enforcement program. Rod Sims is clearly focused on pursuing larger, more complex and ultimately more important enforcement cases that his predecessor. However, with this strategy comes obvious risks - namely that the ACCC will start losing a greater number of cases than it has in the past.

A significant impact on the ACCC’s financial position will be the legal costs it has to pay when it does end up losing large, long running cases. The ACCC has already felt the financial impact of its loss in the Metcash-Franklins case which no doubt cost the organization many millions of dollars in legal costs. It is also looking at paying further large costs orders following its losses in the Google sponsored links case and the ANZ price fixing case. Indeed, a loss in the Visa section 46 case could very well bankrupt the ACCC entirely. However, the ACCC must not be dissuaded from pursuing important enforcement cases due to the fear of losing and having to pay significant legal costs. 

Having said that the ACCC must also be honest in admitting that its organization’s structure it far too top heavy and that it’s Senior Executive Service is too expensive at $17 million a year. It should also acknowledge that it is spending too much money on external consultancies. The ACCC must take the initiative in conducting its own root and branch review of its senior management structures, its use of external consultancies and the way in which it conducts litigation. If it conducts such a review in an open and transparent manner, it will quickly realize that it can make significant reductions in its cost of doing business, which will in turn help it to get a lot more bang for its buck.

[2] ACCC to run out of Money, says Joe Hockey, Sydney Morning Herald, 7 November 2013 at http://www.smh.com.au/business/accc-to-run-out-of-money-says-joe-hockey-20131107-2x2wd.html
[3] Improving Regulation requires Sharper Focus on Regulators, Business Council of Australia, 22 November 2013 at http://www.bca.com.au/newsroom/improving-regulation-requires-sharper-focus-on-regulators
[5] Above footnote 1, 37.
[6] Above footnote 4, 279.
[7] Ibid 278.
[8] Ibid 219.
[9] Ibid 231.

[10] Toyota Australia gives an undertaking to ACCC on ‘leather’ claims, ACCC news release, 12 February 2013 at http://www.accc.gov.au/media-release/toyota-australia-gives-an-undertaking-to-accc-on-%E2%80%98leather%E2%80%99-claims

[11] Samsung Electronics Australia provides ACCC with undertaking over energy savings claims, ACCC news release, 21 January 2013 at http://www.accc.gov.au/media-release/samsung-electronics-australia-provides-accc-with-undertaking-over-energy-savings

Friday, 5 July 2013

Usual Suspects: The Credit Default Swap Investigation

This article first appeared on the CCH Law Chat website on 4 July 2013


On 1 July 2013, the European Commission (EC) issued a statement of objections to thirteen of the world's largest investment banks concerning alleged anti-competitive conduct in relation to credit default swaps.[1] In its statement of objection the EC alleged that these investment banks may have engaged in a “serious breach” of Article 101 of the Treaty on the Functioning of the European Union (TFEU). While it is still very early days and details of the alleged illegal behaviour remain quite sketchy, if the EC’s investigation is successful, a number of the world's largest investment banks may be liable to pay billions of dollars worth of fines.

What are credit default swaps?

The EC’s investigation relates to a financial derivative product called a Credit Default Swap or a CDS.

A credit default swap is a form of insurance against possible default in the payment on an underlying debt. A company sells its credit risk to a buyer for a fee. In return, the buyer agrees to indemnify the seller against its losses if the borrower fails to meet its obligations under the loan.

Satyajit Das in his book, Traders, Guns and Money: Knowns and Unknows in the Dazzling World of Derivatives[2] explains why companies choose to enter into a CDS contract:

The basic idea of a CDS is simple. Assume that a bank has made a loan to a client. The bank now wants to sell the risk on the loan; it has too much exposure to the client, industry or country. This is “concentration risk’, the opposite of diversification. Alternatively, the bank is worried – it knows something that makes it worry about whether it will get its money back. The reason doesn’t matter, the bank just wants to sell the credit risk on the loan.
The bank finds someone who wants the risk. They like the company; they have little exposure to the company, industry or country; they don’t think the company will default; they are unaware of the risks. Whatever the reason, the investor is happy to take on the risk. The two parties enter into the CDS.
Das goes on to explain the main advantages of using CDS’s to sell risk. The first advantage is that it is, for all practical purposes, “insurance” without being considered “insurance” in a legal sense. This means that the various investment banks which trade in CDS’s do not have to obtain an insurance licence to trade CDS’s. The consequence of this is that the trade of CDS’s is not subject to any form of government regulation, including compliance with any mandatory disclosure rules.

Das goes on to list the other main advantages of using CDS’s to sell risk:[3]

It has many advantages: you don't have to do anything with the loan; you don't have to tell the borrower or get their consent; you don't have to exactly match the terms the loan. You can also fiddle the pricing. You keep the loan on your books. You get rid of the risk.

The CDS allows you to short credit easily, which allows you to profit from the decline in the fortunes of the company. Before the CDS, this was hard. As the CDS is a derivative contract, it is also off-balance-sheet. It can be leveraged, infinitely. It is the killer derivative.
The other significant characteristic of CDS’s is that they are traded “over-the-counter” (OTC), rather than being traded through exchanges.

OTC trading involves private and bilateral negotiation between buyers and sellers of CDS’s, with the investment bank acting as the intermediary. The investment banks charge both the buyer and seller fees for organising the swap.

How big is the CDS market?

According to the EC the CDS market is worth €10 trillion with almost 2 million active CDS contracts world wide. This is the value of the amount of credit risk covered by the CDS contracts, but not the value of the actual CDS transactions.

The actual payment flows from CDS contracts are is considerably less in terms of the fees which sellers pay to buyers for entering into a CDS, as well as the payments made by buyers to sellers in event that a borrower defaults on their loan.[4]

What has the EC alleged?

The EC has alleged that between 2006 and 2009 thirteen investment banks colluded to prevent International Swaps and Derivatives Association, Inc (ISDA) and Markit Group Limited (Markit) from issuing licences for data and index benchmarks to exchanges that proposed to enter the CDS market.[5]

In order to participate in the CDS market, new entrants must first obtain a licence from ISDA and Markit for data and index benchmarks.

The EC claimed that the thirteen investment banks were able to collude in directing ISDA and Markit not to issue licences to both Deutsche Borse and Chicago Mercantile Exchange through their ownership and control of those two organisations.

The thirteen investment banks which have been named in the EC investigation are:

· Merrill Lynch;

· Barclays;

· Bear Stearns (now part of JP Morgan);

· BNP Paribas;

· Citigroup;

· Credit Suisse;

· Deutsche Bank;

· Goldman Sachs;


· JP Morgan;

· Morgan Stanley;

· UBS; and

· Royal Bank of Scotland.

The EC has also sent a statement of objections to ISDA and Markit.

On issuing the statement of objections, Joaquin Alumina, the Vice President of the EC Responsible for Competition Policy also released a press statement about the CDS investigation. In particular, Mr Alumina stated that:

To launch these exchange traded credit derivatives, these exchanges needed licences for data and index benchmarks. But ISDA and Markit refused to provide these licences because – according to our findings at this stage of the investigation – the banks had instructed them not to do so. In addition, several investment banks sought to shut out the exchanges in other ways, for example by coordinating amongst themselves the choice of their preferred clearing house. In the end, neither Deutsche Borse or CME managed to enter the market. [6]
Alumina went on to explain the EC's theory as to why the investment banks had decided to engage in this alleged illegal conduct:
In sum, exchange-trading of credit derivatives improves transparency and market stability. But the banks acted collectively to prevent this from happening. They delayed the emergence of exchange trading of the financial products because they feared that it would reduce their revenues. This, at least, is our preliminary conclusion. If confirmed, such behaviour would constitute a serious breach of our competition rules.[7]
In other words, the EC has alleged that the investment banks, colluded to preserve the OTC trading system for CDS’s, in order to maintain their high profit margins. These high profit margins came about because of the lack of price transparency which results from the OTC trading of CDS’s.

The EC believes that trading CDS’s on an exchange will result in much greater price transparency both in terms of the fees paid by the seller to the buyer for taking on the credit risk, as well as in terms of the fees paid by the parties to the intermediary investment banks for arranging the CDS.

The EC’s has also suggested that the investment banks conduct was motivated by a desire to prevent a significant amount of the current CDS trade (which consists of over 2 million CDS contracts) moving out of the OTC trading environment and into exchanges. If this happened, buyers and sellers would no longer have to use intermediary investment banks to arrange CDS’s, but rather could choose to purchase or sell a CDS directly through the exchanges. Such a move would have resulted in the investment banks losing a significant amount of the fees which they currently derive from the sale of CDS’s.

A related benefit of CDS’s being sold on exchanges, as suggested by the EC, is that exchanges are safer and more stable than OTC trading. This greater safety and stability would have provided both buyers and sellers with significant transaction cost benefits, as well as improving the efficiency and liquidity of the CDS market.

What happens next?

The thirteen investment banks, ISDA and Markit now have an opportunity to provide the EC with an explanation of their conduct in order to avoid the imposition of sanctions.

While it is not clear what explanations or justifications the merchant banks will seek to provide to the EC in relation to their alleged illegal conduct, one issue that they will be very mindful of, are the sanctions which the EC could impose for what appears to be a “serious breach of competition rules”. Any finding of an infringement of EU competition rules, such as Article 101 of the TFEU, could lead to the imposition of fines of up to 10% of the annual worldwide turnover of each of the thirteen investment banks.


The EC’s current investigation of the CDS market appears to be yet another example of very serious and blatant illegal anticompetitive conduct being engaged in by the world’s leading investment banks. In addition to this particular investigation, the EC is continuing its major investigation into allegations that many of these very same investment banks also colluded in an attempt to manipulate the LIBOR. The EC has recently announced that it is expecting to conclude its investigations into the alleged LIBOR manipulation by the beginning in 2014.

While it is difficult to predict the outcome of the EC's investigations, it would seem likely that if the EC’s CDS and LIBOR investigations are successful, the combined penalties which may be imposed by the EC against these investment banks will total many billions of dollars. What is also certain about these investigations is that no criminal charges will ever be laid by the EC against any bank or any bank officer or employee for the simple reason that the EC does not have criminal jurisdiction in relation to breaches of competition laws.

It is hoped that the announcement of the EC’s CDS statement of objections, following so soon after the announcement of the EC’s LIBOR investigation, will provide the stimulus for a renewed debate on the need for the EC to introduce criminal sanctions for breaches of competition laws. The fact that the EC cannot seek criminal sanctions for serious contraventions of competition laws is a serious shortcoming. This is becoming particularly evident as the EC pursues yet another investigation against the usual suspects, namely the world’s major investment banks, for what appears to be a serious, blatant and highly damaging contravention of competition laws.

[1] Antitrust: Commission sends statement of objections to 13 investment banks, ISDA and Markit in credit default swaps investigation at http://europa.eu/rapid/press-release_IP-13-630_en.htm?locale=en

[2] Satyajit Das, Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives, Prentice Hall – Financial Times, 2005, p. 271.

[3] Ibid., p. 273.

[4] Antitrust: Commission sends statement of objections to 13 investment banks, ISDA and Markit in credit default swaps investigation – Frequently Asked Questions at http://europa.eu/rapid/press-release_MEMO-13-632_en.htm?locale=en

[5] Footnote 1, above.

[6] Statement on CDS (credit default swaps) investigation at http://europa.eu/rapid/press-release_SPEECH-13-593_en.htm?locale=en

[7] Ibid.

Wednesday, 12 June 2013

Smoke and Mirrors - Libor Settlements


In late 2012 and early 2013, two more banks, namely UBS AG (UBS) and Royal Bank of Scotland (RBS) reached settlements with regulators on both sides of the Atlantic concerning LIBOR manipulation. In both of these settlements, the regulators involved have been trumpeting their success in obtaining such large dollar amount settlements. UBS paid a total fine of $US1.5 billion while RBS agreed to pay $US610 million.

If one adds these amounts to the $US450 million already obtained from Barclays in mid-2012, the total penalties which have been paid by the major banks for LIBOR manipulation already exceeds $US2.5 billion. With the prospect of a further 13 banks likely to settle allegations of LIBOR manipulation, the total amount of fines levied against the banks could well exceed $US12 billion.

However, the reality is that the banks are getting off lightly. When one analyses the settlements reached between the financial and anti-trust regulators and UBS, one appreciates that the settlements have been carefully crafted to do minimal damage to the banks. The settlements have been structured to allow both UBS and RBS to plead guilty to wire fraud charges by their Japanese subsidiaries, rather than facing criminal fraud and anti-trust charges in the US.

Regulators appear to have allowed the banks to plead out to relatively minor criminal charges in carefully selected jurisdictions, so that they can avoid more serious consequences such as jail time for senior executives and even the loss of their US banking licences

The main culprit in the settlements is the US Department of Justice (DOJ). Other regulators, such as the Financial Services Authority (FSA) in the UK and the Commodities Futures Trading Commission (CFTC) in the US, do not have criminal jurisdiction. Therefore, the only sanctions they can seek are civil pecuniary penalties.

However, the same cannot be said for the DOJ’s Criminal Division or the Antitrust Division, which both have criminal jurisdiction. By not pursuing serious criminal charges against the banks and their senior managers, these two agencies have failed to enforce their legislation properly. Their enforcement efforts should be aimed at adequately punishing wrongdoing in order to achieve both specific and general deterrence. Put simply, these settlements are not going to deter banks from continuing to engage in fraud and cartel behaviour in the future.

In this post, I will discuss the recent LIBOR settlements, with a particular focus on the UBS settlement.

UBS Settlement

On 19 December 2012, the US Department of Justice announced it settlements with UBS.[1] The specific details of the settlement were as follows.

UBS Japan signed a plea agreement with the US government admitting criminal conduct, and agreeing to pay a $100 million fine.

In addition, UBS AG, the parent company of UBS Japan headquartered in Zurich, entered into a non-prosecution agreement (NPA)[2] with the US government requiring that the company:

  •  an additional $400 million penalty;
  • admit and accept responsibility for its misconduct; and 
  • continue cooperating with the DOJ in its ongoing investigation. 
The NPA stated that the settlement reflected UBS AG’s substantial cooperation in discovering and disclosing LIBOR misconduct within the financial institution and recognized the significant remedial measures undertaken by new management to enhance internal controls.

In addition, UBS AGS agreed to pay a further $1 billion in regulatory penalties and disgorgement:
  • $700 million as a result of the CFTC action; 
  • $259.2 million as a result of the FSA action; and 
  • $64.3 million as a result of the Swiss Financial Markets Authority action.
Therefore, the total penalty and disgorgements paid by UBS in relation to LIBOR manipulation was approximately $1.5 billion.

Setting LIBOR

As outlined in the Statement of Facts,[3] which accompanied the NAP, it appears that until 1 September, 2009, UBS’s LIBOR submissions were made by UBS’s derivatives traders. In other words, the very UBS staff members who had the most to gain from manipulating the LIBOR, namely derivatives traders, were responsible for calculating and submitting UBS’s LIBOR submissions.

On 1 September, 2009, a new UBS department called “Asset and Liability Management” (ALM) took over the LIBOR submission process from the derivatives trading desks. This change came about after UBS’s Compliance Department reached the conclusion that there was an inherent conflict of interest in having derivatives traders determining UBS’s daily benchmark submissions.

Despite coming to this obvious conclusion, UBS continued to allow derivatives traders to provide input to ALM on UBS’s LIBOR submissions. Each day, approximately 15 minutes before ALM made its LIBOR and Euribor submissions on behalf of UBS, derivatives traders in a given currency would input their assessment of LIBOR and Euribor changes into a shared spreadsheet. The ALM submitters would then consider that input, along with the previous day’s submissions, and work out the LIBOR submissions for that day.

It also appears that from as early as 2001 through at least June 2010, certain UBS derivatives traders requested and obtained benchmark interest-rate submissions to benefit their trading positions.

These derivatives traders requested, and sometimes even directed, certain UBS LIBOR, Euroyen TIBOR, and Euribor submitters to submit benchmark interest rates that would benefit the traders’ trading positions.

The derivatives traders made these requests in electronic messages, telephone conversations, and in-person conversations. The LIBOR, Euroyen TIBOR, and Euribor submitters regularly agreed to accommodate the derivatives traders’ requests and directions for favourable benchmark interest rate submissions.

Examples of LIBOR manipulation

The following are some examples of the types of conduct which was occurring in UBS, on an almost daily basis, at the relevant time:

Example 1
On Monday, November 20, 2006, Trader-1 asked the UBS Yen LIBOR submitter (“Submitter 3”), who was substituting for the regular submitter (“Submitter 1”) that day:
Submitter 3 - “hi . . . [Submitter-1] and I generally coordinate ie sometimes trade if ity [sic] suits, otherwise skew the libors a bit.”
Trader-1 - “really need high 6m [6-month] fixes till Thursday.”
Submitter 3 - “yep we on the case there . . . will def[initely] be on the high side.”
The day before this request, UBS’s 6-month Yen LIBOR submission had been tied with the lowest submissions included in the calculation of the LIBOR fix. Immediately after this request for high submissions, however, UBS’s 6-month Yen LIBOR submissions rose to the highest submission of any bank in the Contributor Panel and remained tied for the highest until Thursday – as Trader 1 had requested,
Example 2
On March 29, 2007, Trader 1 asked Submitter 1:
Trader 1 - “can we go low 3[month] and 6[month] pls? . . . 3[month] esp.”

Submitter 1 - “ok”
Trader 1 - what are we going to set?
Submitter 1 – “too early to say yet . . . prob[ably] .69 would be our unbiased contribution”
Trader 1 - ok wd really help if we cld keep 3m low pls
Submitter 1 - as i said before - i [don’t] mind helping on your fixings, but i'm not setting libor 7bp away from the truth. . . i'll get ubs banned if i do that, no interest in that.
Trader 1 - ok obviousl;y [sic] no int[erest] in that happening either . . . not asking for it to be 7bp from reality anyway any help appreciated[.]
Trader 1 received the help he requested. Although Submitter-1’s “unbiased contribution” of the 3-monthYen LIBOR submission would have been .69 that day, he lowered his/her submission to.67, as Trader-1 requested

Example 3

On April 4, 2008 electronic chat between Trader 1 and Submitter 2, the following exchange occurred:
Trader 1 - have you put the libors in?
Submitter 2 - y[es] . . . any changes?
Trader 1 - oh was going to ask high 6m if not too late
Submitter 2 - i input 95 . . . which is on the lower side
Trader 1 - ok is it too late to change? . . . if not no drama
Submitter 2 - i try to change it now but cannot guarantee if it gets accepted
Submitter 2 - just cahnged [sic]it to 0.98
In this example, the UBS submitter was able to change the UBS submission after it had been lodged.
Example 4

On March 31, 2009 Trader 1 asked Broker C to help influence 9 of the 16 Contributor Panel banks by convincing them to lower their LIBOR submissions from the previous day, thus lower the resulting 1-month and 3-month Yen LIBOR fix:
Trader 1 - mate we have to get 1m and 3m down . . . 1m barely fell yesterday . .. real important.
Broker C - yeah ok
Trader 1 - banks to have a go w in 1m are
Trader 1 - [Bank-F]
Trader 1 - [Bank-G]
Trader 1 - [Bank-H]
Trader 1 - [Bank-E]
Trader 1 - [Bank-I]
Trader 1 - [Bank-C]
Trader 1 - [Bank-A]
Trader 1 - [Bank-J] 
Trader 1 - and [Bank-K]
Trader 1 - pls
Broker C - got it mate
That day, consistent with Trader-1’s request, 6 of the 9 Contributor Panel banks listed above lowered their 1-month Yen LIBOR submissions relative to the previous day, and the resulting published 1-month Yen LIBOR fix dropped by a full basis point from the day before.
In other words, it would appear that the Broker was able to convince up to six of the banks involved in submitting LIBOR rates to collude in relation to their submissions for the 1-month Yen LIBOR rate.
Example 5
On 22 July, 2009 Trader 1 described his plan to coordinate Yen LIBOR submissions with other Contributor Panel banks over the next few weeks while staggering drops in submissions so as to avoid detection 
Trader 1 - 11th aug is the big date . . . i still have lots of 6m fixings till the 10th
Broker A1 - if you drop your 6m dramatically on the 11th mate, it will look v fishy, especially if [Bank D] and [Bank B] go with you. I'd be v careful how you play it, there might be cause for a drop as you cross into a new month but a couple of weeks in might get people questioning you.
Trader 1 - don't worry will stagger the drops . . . ie 5bp then 5bp
Broker A1 - ok mate, don't want you getting into shit
Trader 1 - us then [Bank B] then [Bank D] then us then [Bank B] then [Bank D]
Broker A1 - great the plan is hatched and sounds sensible
Aggravating factors

The Statement of Facts lists many aspects of UBS’s LIBOR manipulation which would be considered by most regulators to be serious aggravating factors, which would justify more serious penalties.

For example, paragraph 22 of the Statement of Facts states:

22. Beginning in 2006, in Zurich, Tokyo, and elsewhere, several UBS employees engaged in sustained, wide-ranging, and systematic efforts to manipulate Yen LIBOR and, to a lesser extent, Euroyen TIBOR, to benefit UBS’s trading positions. This conduct encompassed hundreds of instances in which UBS employees sought to influence benchmark rates; during some periods, UBS employees engaged in this activity on nearly a daily basis. In furtherance of these efforts to manipulate Yen benchmarks, UBS employees used several principal and interrelated methods, including the following:
a) internal manipulation within UBS of its Yen LIBOR and Euroyen TIBOR submissions;
b) use of cash brokers to influence other Contributor Panel banks’ Yen LIBOR submissions by disseminating misinformation; and
c) efforts to collude directly with employees at other Contributor Panel banks, either directly or through brokers, in order to influence those banks’ Yen LIBOR submissions.
In other words, the DOJ obtained evidence which showed that UBS’s conduct had been “sustained, wide-ranging and systematic” and that there had been “hundreds of instances” of UBS seeking to illegally influence the LIBOR. The DOJ also found evidence of collusion.

Furthermore, there was compelling evidence that senior UBS management:

  • were aware of the LIBOR manipulation;
  •  sought to conceal the conduct and
  • sought to obstruct the LIBOR investigation.

36. Certain UBS managers, and senior managers, were aware of the internal manipulation of Yen LIBOR and Euroyen TIBOR submissions by derivatives traders as described above….]

37. The majority of UBS Yen LIBOR and Euroyen TIBOR submitters, Yen derivatives traders, and their supervisors – as well as the more senior managers at UBS who were aware of this conduct – knew that the manipulation of Yen LIBOR and TIBOR submissions was inappropriate, yet continued to encourage, allow, or participate in this conduct…

Another example of the knowledge of senior UBS managers related to the involvement of the UBS representative on the British Banking Association (BBA) LIBOR Committee. His role on the BBA Libor Committee was to scrutinize LIBOR submissions to make sure they were accurate.

On one occasion, shortly after an UBS Euribor submitter had asked a number of UBS derivatives traders, in an internal UBS online chat forum, what LIBOR rates they wanted, the UBS BBA Committee representative responded by saying “Just be careful dude”. The submitter responded by saying “I agree we shouldn’t ve (sic) been talking about putting fixings for our positions on public chat.”


38. Because UBS’s Yen LIBOR submitters, derivatives traders, and their managers knew this conduct was improper, they tried to conceal the manipulation. For example, after an August 10, 2009 Trader-1 email request to lower 6-month Yen LIBOR, a LIBOR submitter (“Submitter-4”) complained to Trader-1’s manager that these requests should not be in writing. Moreover, Trader-1 would sometimes request that LIBOR submissions be moved in small increments over time to avoid detection.
The Statement of Facts records the fact that after media reports regarding the banks suspected LIBOR manipulation first appeared, UBS managers cautioned staff to avoid creating written records and instead suggested that they use mobile phones to contact brokers in future.


39. Finally, and for the same reason, a UBS derivatives desk manager sought to obstruct the investigation into LIBOR manipulation. In December 2010, Submitter-4, the UBS derivatives desk manager who had supervised Submitter-2 in 2009, instructed Submitter-2 to lie when interviewed by UBS attorneys during the investigation into LIBOR manipulation. Among other things, the UBS manager instructed Submitter-2 to:

  • falsely claim that the UBS Yen trading desks did not have any derivative positions with exposure to Yen LIBOR;

  • avoid mentioning Trader-1;

  • falsely indicate that the Yen LIBOR submission process did not take into account trading positions;

  • falsely claim that they never moved the Yen LIBOR submissions to benefit the Yen trading desks;

  • falsely claim that when contributing Yen LIBOR submissions, UBS tried to be “as close to the market as possible.”
The following quote best captures the view within UBS that LIBOR rates were nothing more than fictitious numbers:
UBS Employee - why is the [Investment Bank] cash curve for USD so much higher than Libor? offered 35bps above libor currently
ALM employee - because the real cash market isn't trading anywhere near Libor . . . Libors currently are even more fictitious than usual
UBS Employee - isn't libor meant to represent the rate at which banks lend to each other? 
ALM employee - that's the theory . . . in practise, it's a made up number . . .hence all the critisism it was getting a few months ago
UBS Employee - why do banks undervalue it in times like this?
ALM employee - so as to not show where they really pay in case it creates headlines about that bank being desparate for cash . . . I suspect
Smoke and mirrors

As was the case with the Barclays settlement, the DOJ was keen to trumpet its own success. As stated by Attorney General Holder:

By causing UBS and other financial institutions to spread false and misleading information about LIBOR, the alleged conspirators we've charged – along with others it UBS – manipulated the benchmark interest rate upon which many transactions and consumer financial products are based. They defrauded the company's counterparties of millions of dollars. And they did so primarily to reap increased profits, and secure bigger bonuses, for themselves.
Today's announcement – and $1.5 billion global resolution – underscores the Justice Department’s firm commitment to investigating and prosecuting such conduct and to holding the perpetrators of these crimes accountable for their actions.
Not to be outdone, the Assistant Attorney General of the Justice Department’s Criminal Division, Mr Lanny Breuer stated:
UBS manipulated one of the cornerstone interest rates in our global financial system. This scheme alleged is epic in scale, involving people have walked the laws of some of the most powerful banks in the world. Today's agreements by UBS Japan to plead guilty, the charges against individual alleged perpetrators of these crimes, and our agreement recognizing the steps being taken by UBS AG to right itself demonstrates the Justice Department's determination to hold accountable those in the financial marketplace who break the law. We cannot, and we will not, tolerate misconduct on Wall Street of a kind admitted to by UBS today, and by Barclays last June. We will continue to follow the facts and the law where ever they lead us in this matter as we do in every case.
Finally, Deputy Asst Attorney General Scott D. Hammond of the DOJ’s Anti-Trust Division, an enforcer noted for his hardline and uncompromising approach to cartel behaviour, added:
The criminal complaint charges two senior UBS traders with colluding to manipulate the Yen LIBOR interest-rates for the purpose of improving training positions held by Hayes and UBS. Coordinating the movement of interest rates even by a very small margin meant higher profits and bigger bonuses for the conspirators at the expense of those that relied on LIBOR as a reference rate.
One has to ask oneself the simple question – if the conduct engaged in by UBS was so egregious and blatant, why weren’t UBS and its senior managers charged with criminal offences for both fraud and cartel conduct? Further, why was the only criminal charge against a Japanese subsidiary of UBS and why was that charge only for wire fraud?

The simple answer to these questions is that the DOJ has compromised its settlements to such an extent that they have failed to deal effectively with the underlying criminality of the conduct. It is inappropriate from any proper enforcement perspective to accept large cash settlements from perpetrators of serious criminal offences in return for not pursuing serious criminal charges against them.

Put plainly, theses settlements represent nothing more than banks buying their way out of criminal liability.

One cannot criticise such organisations as the FSA or the CFTC from accepting large cash settlements. These organisations do not have criminal jurisdiction and cannot file criminal charges against corporations or send individuals to jail. On the other hand, the DOJ’s Criminal Division and the Antitrust Division do have criminal jurisdiction.

The DOJ should have charged UBS’s parent company, its US subsidiaries and its senior managers with multiple criminal offences, including wire fraud and cartel offences.

After accepting three patently inadequate settlements from Barclays, UBS and RBS, it will be increasingly difficult for the DOJ to get serious about LIBOR manipulation and collusion in the future and to pursue more serious penalties. Other banks will no doubt argue that they should not be treated any differently or more harshly than Barclays, UBS and RBS, who have received proverbial “slaps on the wrist”. Indeed, it may be left to the UK Serious Fraud Office to pursue appropriate criminal charges against the remaining banks to ensure that they are ultimately held to account for their serious and blatant criminal conduct.

[1] UBS Securities Japan Co. Ltd. to Plead Guilty to Felony Wire Fraud for Long-running Manipulation of LIBOR Benchmark Interest Rates at DOJ website - http://www.justice.gov/opa/pr/2012/December/12-ag-1522.html
[2] Non-Prosecution Agreement – dated 18 December 2012 - http://www.justice.gov/iso/opa/resources/1392012121911745845757.pdf
[3] Statement of Facts – Appendix A to Non-Prosecution Agreements - http://www.justice.gov/iso/opa/resources/6942012121911725320624.pdf

Tuesday, 30 April 2013

NEWS FLASH - Infringement notice penalties increased substantially

In January 2013, the ACCC issued the following advice on its website:

Important notice - Increase in value of penalty units January 2013

Important notice for printed and electronic information and publications provided by the Australian Competition and Consumer Commission

The ACCC is reviewing this website and its publications to reflect the increase in the value of penalty units.
Increase in the value of penalty units

Several of the penalties administered by the Australian Competition and Consumer Commission (ACCC) are calculated using penalty units rather than dollar figures. On 28 December 2012 the value of a penalty unit increased from $110 to $170.
The implications of this legislative change are that, in relation to penalties calculated using penalty units:

  • administrative penalties (in the case of the ACCC, infringement penalty notices) will be increase 

  • maximum available penalties for some court-imposed fines will also rise.
The new penalty unit value will only apply to contraventions that occur on or after 28 December 2012. This means that the changes will not impact on contraventions that occur before 28 December 2012, or current proceedings for contraventions that took place before that date.

The penalty unit value has not been adjusted since 1997.

Under the new legislation, the value of the penalty unit will be reviewed every three years.

In other words, all penalties in the Australian Consumer Law (ACL) which are expressed in terms of penalty units have increased by more than 50%.

Significantly, the penalties which can be obtained by the ACCC through an infringement notice have increased, as follows:

  • individuals from $1,320 to $2,040 per contravention 
  • unlisted corporations from $6,600 to $10,200 per contravention 
  • listed corporations from $66,000 to $102,000 per contravention 
The penalties for contraventions of other substantive provisions of the ACL are expressed in dollar terms, so they have remained at the same levels as before December 2012.