LIBOR is the abbreviation for London Inter Bank Offer Rate. This is the interest rate which banks charge for lending to each other. Although LIBOR changes throughout the day, the formal or published LIBOR is fixed once a day by taking the average of LIBOR submissions from selected (presently 16) large banks in London. It represents the average rate across the universe of selected banks for borrowing in a given currency. In other words LIBOR is not set in the market through a price discovery or trading process but by taking the average (after excluding the 4 highest and 4 lowest quotes) of the submitted rates.
And that is the crux of the current LIBOR crisis.
LIBOR is used widely by businesses, investors, financial institutions, traders and markets to borrow money. It is a benchmark for determining interest rates.
Why is it so important? Because LIBOR is considered to be one of the most liquid and quoted interest rate benchmarks in the world. From interest rate swaps to floating rate notes, from cross currency swaps to corporate bonds, from credit derivatives to catastrophic bonds everyone uses LIBOR as the price setting benchmark.
Transactions valued by LIBOR reach trillions of pounds. To quantify, LIBOR is the benchmark for over a staggering $360 trillion in securities. This means that even if it is wrong by 0.01% or one basis point it would mean that $36 billion in value was wrongly recorded.
According to the FSA report (download the full Barclays LIBOR FSA report here), LIBOR and EURIBOR are the most prevalent benchmark rates for exchange traded as well as over-the- counter interest rate contracts. For OTC interest rate derivatives, the amounts outstanding in the first half of 2011 are estimated at $554 trillion while for short term interest rate derivatives traded on the exchange LIFFE in 2011 the outstanding amounts stand at 477 trillion Euros. This shows how high the stakes really are.
Et tu Barclays? How deep did the LIBOR crisis go?
In the global financial crisis of 2007-08, the media had seen Barclays refusing government bail outs. At a time where many major banks were is most respects nationalized, Barclays managed to steer clear of increased government control managing to get capital backing from Middle East investors. However the recent LIBOR crisis leaves one wondering whether Barclays would have been as fortunate if LIBOR submissions had been based on actual LIBOR submissions rather than rigged rates.
Barclays presenting misleading rates to manipulate markets, However is not a new incident. Attempts to manipulate markets have occurred in the past and were brought to the notice of relevant regulating bodies like the BBA & the FSA.
According to a report by FSA, 257 attempts to fix LIBOR and EURIBOR Rates were made by Barclays between January 2005 and June 2009.
To the media, Barclays had said that it acted “in defiance of the market” instead of submitting incorrect rates. In 2009 British Bankers’ Association circulated guidelines for all those banks for consistency in the setting of LIBOR rates, in particular that the submitted rates should not be influenced by derivatives traders to avoid conflicts of interest and that in no way should these rates consider the impact of negative media effects (e.g. higher submissions taken by the media as a sign that the bank was having difficulty in raising capital/ borrowing). This would have been an ideal opportunity for Barclays to have reviewed and improved its processes and controls but the guidelines were was brushed aside by Barclays and the rate rigging continued unabated. Barclays internal systems and controls in risk management were also so weak that it could not stop this problem from happening in the first place nor stop it from recurring once it was reported and brought to the attention of the Compliance group at the bank. The most damning condemnation is the fact the Barclays had no effective controls related to LIBOR and EURIBOR submission processes before December 2009.
Even when Compliance was made aware of anomalies in the rate setting process there remained a lack of communication between different levels and departments. Barclays effectively did not consider the submitting process to generate significant risks and hence left it to itself.
There is evidence of rigging of rates by derivatives traded and submitters as well as cases where Barclays’s tried to influence the rates quoted by their counterparts, through external traders. The numbers and the degree of familiarity in recorded communications make it appear as if manipulating rates had become part of the rate setting routine.
In one particular instance mentioned in the FSA final notice report a trader is recorded as saying.
“We have 80 billion yards (fixings) 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.”
Another conversation recorded a submitter admitting to a trader that he was posting a different value from what he actually should be posting on the trader’s request. The trader acknowledges the deed with gratitude saying that if he ever wrote a book on the business then the submitter’s name would be written in golden letters”.
The extent of the cooperation or collusion between submitters and traders is evident from the following communication:
“For you, anything. I am going to go 78 and 92.5. It is difficult to go lower than that in threes, looking at where cash is trading. In fact, if you did not want a low one I would have gone 93 at least”.
Sometimes submitters even offered to submit higher rates on trader’s requests so that Barclay’s submissions would be excluded from the LIBOR average thus leading to a lower fixed published LIBOR rate. FSA’s analysis of the submissions consistency made by traders during the specified time intervals reveals that this was 70% consistent for LIBOR and 86% for LIBOR and 86% for EURIBOR.
The riggings were not just made internally but there is evidence that Barclays tried to influence the rate submissions of other banks. The final notice by the FSA states that there were at least 12 LIBOR and 20 EURIBOR requests that were made by external traders who had once worked for Barclays but were now working for other banks.
There were instances when a senior submitter of rates in Barclays felt aggrieved at submitting false rates but the matter was not accelerated any further by Compliance or the Board and was not brought to the attention of the FSA. In the words of the submitter:” My worry is that we (both Barclays and the contributor bank panel) are being seen to be contributing patently false rates. We are therefore being dishonest by definition and are at risk of damaging our reputation in the market and with the regulators”.
In February 2012, FSA had warned the Board of having lost trust in its Chief Executive, Bob Diamond and his management team. Again no action was taken by anyone at Barclays at the time.
The bullet train of chain reactions. The Barclays LIBOR timeline.
On 27th June 2012, Barclays admitted to misconduct.
The total fine imposed upon it was quite hefty; £290 million-which is a record fine in London. However it is nothing compared to the losses caused to others by Barclays.
The next day, stock investors reacted un-forgivingly which led to Barclays shares falling by 15% on a single day, losing £3.2 billion off the bank’s market capitalization or market value.
Two days later, the matter was being considered at the national government level when Prime Minister David Cameron compelled regulators to get to the depth of the scandal and uncover all the hidden facts and faces.
On Sunday, 1st July 2012, the shareholders demanded the resignations of the Chairman and Chief Executive.
On Monday, 2nd July, 2012, chairman Marcus Agius succumbed to the pressure and resigned.
Mr. Diamond had so far been resisting all pressure and said that he wouldn’t resign. That was the first signal; of his forthcoming resignation from the past we have learnt that if someone says they will not resign it means that they probably will. David Cameron also announced that Barclays would now be subject to a parliamentary review.
On the following day, 3rd July 2012, the inevitable happened with Mr. Diamond submitting his resignation on 3rd July. The media had another heyday based on allegations made by Mr. Diamond that the Bank of England and Whitehall senior officials coerced Barclays into manipulating the LIBOR rate.
In the Parliamentary review 4th July, Mr. Diamond mentioned that the real cause was bad culture and lack of stronger controls at Barclays. Further he claimed that the exact number of traders involved in this wrongdoing was 14.
Surprisingly (or unconvincingly depending on how you look at it), Mr. Diamond claimed that he had no knowledge of the severity of the rigging until the matter was brought to light by the FSA report. In support of his claims of coercion by the BOE he showed a memo of a conversation on October 29, 2008 with the deputy governor of the Bank of England Paul Tucker which suggested that the governor hinted that Barclays did not need to submit such high rates.
However, in the end, Mr. Diamond took the responsibility for the scandal instead of blaming it on government authorities.
And the music stops:
What is sure and certain, however, is the public outrage.
A Sunday Times YouGov poll asked people whether they believed that banks had improved their behavior after the 2008 crisis. 1% agreed;
A negligible 1%. What is worse though is that nearly 50% of the respondents believed that banks are either corrupt (49%) or incompetent (45%).
Once again, the regulators are acting when the damage has already been done (seeking to review the methodology of the LIBOR rate setting process, the controls and processes at rate submitting banks, etc) instead of being the first ones to highlight anomalies and to take adequate measures for eliminating these before they caused any serious harm.
And remember Nick Leeson? the rogue trader behind the Barings Bank debacle that cost the bank £827 million and which subsequently led to its bankruptcy. He now says that Barclays should be penalized for an amount greater than the £290 million already imposed.
In light of this crisis Moody’s has downgraded Barclays’ outlook from ‘stable’ to ‘negative’. It comes as no shock, though, to learn that Mr. Diamond despite the wrongdoings that occurred on his watch and for which he should be held accountable will receive at least £2 million in benefits and another £20 million in bonuses from Barclays.
The lessons learnt:
It is about time we realized that there are NO lessons learnt. Banks and financial institutions find a new recipe for disaster that leave the public and taxpayers bearing the bitter after taste. And the regulators always lag behind. We hear bad culture, ethics, miscommunication, group pressure, mismanagement and abuse and exploitation of control of a few etc being touted as reasons, but there is no end to these crises, is there? How many times have we heard these same reasons before?
But why this hypocrisy of targeting just Barclays? Barclays was certainly not alone in manipulating the LIBOR rate. Now HSBC, Citigroup, UBS and RBS are also under investigation of partnering in LIBOR manipulation. When grilled by MPs Mr. Diamond said that there were bigger liars than Barclays on the loose in the market.
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