[Misconduct] Libor Fixing Scandal - A Study in Greed & Failed Controls

BACKGROUND

Bankers ensure that any un-needed surplus would be deposited by the dealers towards the end of a trading day. They would place this money on overnight deposits with other banks. The benchmark for interest payment on this deposit would be the Libor (or Euribor).

Settlement rate was not determined by what rates were actually in the market. Instead, the British Banker’s Association (BBA) polled banks, asking them what the rates were. The highest and lowest quoted rates were discarded and the rest were averaged, giving the settlement rate. 

The Libor was also used as an "weather report" of what conditions were in the market that day and a rough indicative of the banks' financial condition.  

THE SCANDAL AND DETAILS

Derivatives traders worked with the employees who set each bank’s daily Libor submissions (submitters) to manipulate the Libor submissions favourable to their trading positions. The key chronology of incident follows:-

1. The collapse of Northern Rock in 2007 prompted Barclays to artificially lower their Libor submissions to reflect a healthy financial condition.

2. During Mid 2008, media reports alleging global banks were reporting unjustifiably low borrowing costs for Libor.

4. After the fall of Lehmann Brothers in 2008, government officials raised concerns on Barclays’ high Libor submission despite its liquidity position and began to discuss why the Libor was not failing consistently in the UK as in the US. Barclays subsequently lowered its rates.

5. The Commodities Futures Trading Commission begins an investigation in the US into suspected “low-balling” of Libor submissions by global banks.

6. In 2009, Financial Services Authority in the UK officially joins the global investigation, which now also involves the Japanese, the Canadians, the Swiss, and the European Commission.

BANKS & FINES

A list of charges and fines imposed by the FSA & CFTC to the banks & brokers investigated as at July 2014

REPORTED YEAR	CHARGES	BANKS	Aprox fine imposed
2014	Helped set Libor rates tied to the dollar, the yen and other currencies.	Lloyds Bank	$370 M
	Manipulate Libor tied to Yen.	RP Martin (broker-Dealer)	$2 M
2013	Charges related to Euribor	Barclays, Deutsche Bank	$633 M
		R.B.S.	$353 M
		Societe Generale	$606 M
	Charges related to Yen Libor	UBS,R.B.S.	$353 M
		Deutsche Bank	$351 M
		JPMorgan	$108 M
		Citigroup	$95 M
	Charges on inappropriate conduct related to Libor and Euribor	Rabobank	$1 B
	Manipulation of benchmark interest rates (Received incentives to change Libor rate submissions)	ICAP	$87 M
	Charges on felony wire fraud	RBS	$612 M
2012	Multiyear scheme in manipulating interest rates	UBS	$1.5 B
	Charges on manipulating libor to bolster profit and deflect concerns about its financial condition.	Barclays	$450 M

Source :- www.nytimes.com

OPERATIONAL HIGHLIGHTS

1. Classic “conflict of interest” situations created by the way the traders and submitters were organized, including where the Libor submitter and the derivatives trader (Chinese Wall) were one and the same person, and where the submitters were directly supervised by a trader who stood to benefit from the Libor manipulation.

2. Libor manipulations were accomplished through telephone calls, face-to-face requests and in writing via emails and electronic “chats.”

3. Libor fixing operation was akin to cartel collusion.

4. Traders worked with traders at other banks to manipulate Yen Libor and Euribor submissions to benefit the other traders’ positions.

5. Particular bank engaged in so-called, “wash trades” (i.e. risk free  trades that cancelled each other out and which had no legitimate commercial rationale) with the direct intention of generating £170k in fees to broker A in reward for his Libor-setting efforts on behalf of the bank.

6. ‘Informal directives’ on the manipulation of Libor were disseminated by a bank’s Group Treasury and Asset and Liability Management Group focusing on the need to: “protect our franchise in these sensitive markets.” Indicating management was aware of the practice.

IMPACT

1. Libor was manipulated artificially on the first day of each month to affect Mortgage rates on reset dates resulting in wrongful profits.

2. State and localities bought interest swaps to hedge municipal bond sales. Manipulation of Libor caused payments to state and localities’ interest rate swaps to be smaller.

ACTION TAKEN

1. The Danish, Swedish, Canadian, Australian and New Zealand Libor rates have been terminated.

2. Knowingly or deliberately making false or misleading statements in relation to benchmark-setting was made a criminal offence in UK law under the Financial Services Act 2012.

3. Each individual submission that comes in from the banks is embargoed (not published) for three months.

4. From the end of July 2013, only five currencies and seven maturities will be quoted every day (35 rates)

RECOMMENDATIONS & ALTERNATIVES

1. Recommendations to use data from transactions such as market-based quotes for credit default swap transactions and corporate bonds are still in talks.

2. An independent administrator should be responsible to oversee LIBOR setups and statutory regulation on benchmark indices.

3. Stricter code of conducts for banks & harsher criminal offence on manipulating benchmarks.

VIEWS

1. A lack of transparency on how the Libors were set went on for many years and the scandal erupted only after red flags and discrepancies were picked up by the media.

2. The three line of defence (risk management, compliance and audit failed to recognize warning signs such as a trading set-up that encouraged “conflicts of interest” and prioritized making money above compliance and business ethics.

3. There was “awareness of the scheme” and management did nothing to stop it.

4. In 2008, BBA made clear the Libor platform was too large to manage and monitor. No action was taken by regulators.

5. Libor’s popularity made it a reference rate for a large portion of world’s financial contracts and derivatives.

    

6. There are obvious flaws in BBA’s internal controls in monitoring and regulating the Libor when bank executives expressed that Libor was artificially low with BBA responding via a memo to bank reminding that to “submit honest rates”. With the responsibilities resting in the banks, there are no checks and balances by BBA to ensure rates are reflective.