LIBOR scandal escalates
06 July 2012 London
Image: Shutterstock
The former CEO of Barclays, Bob Diamond, has apologised to UK MPs, but denied personal culpability, for the bank’s manipulation of LIBOR rates.
Diamond appeared before the UK Treasury Select Committee after he resigned from his post on 3 July in the aftermath of the LIBOR scandal, which has rocked British banking.
Financial institutions contribute rates that are used in the calculation of LIBOR and EURIBOR. The contributed rates are supposed to reflect each bank’s assessment of the rates at which they can borrow unsecured interbank funds.
For LIBOR, the highest and lowest 25 percent of contributed rates are excluded from the calculation and the remaining rates are averaged to calculate the fixed rates. For EURIBOR, the highest and lowest 15 percent are excluded and the remaining 70 percent are averaged to calculate the fixed rates.
Futures, options, swaps, and other derivative financial instruments traded in OTC markets and on exchanges worldwide are settled based on LIBOR, and mortgages, credit cards, student loans and other consumer lending products often use LIBOR as a reference rate.
According to reports, between 2005 and 2007, and then occasionally through 2009, certain Barclays traders requested that the Barclays LIBOR and EURIBOR submitters contribute rates that would benefit the financial positions held by those traders.
Traders in New York and London made the requests via electronic messages, as well as telephone and face-to-face conversations. The employees responsible for the LIBOR and EURIBOR submissions accommodated those requests on numerous occasions in submitting the bank’s contributions. On some occasions, Barclays’s submissions affected the fixed rates.
On top of Diamond’s resignation, Barclays’s board has agreed to an audit of its business practices. It has paid the US Department of Justice a $160 million penalty to resolve violations. The US Commodity Futures Trading Commission (CFTC) has ordered Barclays to pay $200 million, and the UK Financial Services Authority (FSA) fined Barclays £59.5 million for misconduct, which is the largest fine ever imposed by the FSA.
But the bank’s co-operation with the FSA entitles it to a 30-percent discount under the FSA’s settlement discount scheme, and the Department of Justice’s assistant attorney general Lanny Breuer said that the bank took a significant step towards accepting responsibility for its conduct by being the first institution to provide extensive and meaningful cooperation to the government.
Tracey McDermott, the acting director of enforcement and financial crime at the FSA, said: “Barclays’ misconduct was serious, widespread and extended over a number of years. The integrity of benchmark reference rates such as LIBOR and EURIBOR is of fundamental importance to both UK and international financial markets. Firms making submissions must not use those submissions as tools to promote their own interests.”
“The BBA [British Bankers’ Association] is currently undertaking a review of the way LIBOR is set and will publish its findings shortly. The FSA, along with the other tripartite authorities, is working to support market-led reviews of existing arrangements, with the goal of ensuring such arrangements continue to command the confidence of all stakeholders.”
Breuer called LIBOR and EURIBOR “critically important benchmark interest rates”, but some financial industry professionals have called for the most prevalent benchmark rates to be reassessed. The BBA, which has overseen LIBOR for 26 years, is working with the government and regulators to abolish rate manipulation.
In a recent blog post, Jonathan Cooper, senior consultant at securities and investment research firm Finadium, said LIBOR has a major weakness that needs addressing.
He said: “For LIBOR there aren’t actual trades being reported—only an estimate of where it might trade. It is a major weakness. LIBOR had already lost its effectiveness as a short-term benchmark. It isn’t only the manipulation scandal that has done it in. During the financial crisis the market found out the hard way just how much credit risk was embedded in LIBOR. When OIS spreads were narrow, it didn’t matter much. But when they blew out ... the situation changed completely. Inefficient forwards, a result of the credit risk, made LIBOR useless.”
“Acknowledging that LIBOR was not an appropriate rate, broker/dealers and clearinghouses like LCH.Clearnet started discounting swaps, for mark to market purposes, using OIS curves. At least OIS is linked to the Fed Funds effective ... which is a rate that is both observable and executable, save for some basis risk between Fed Funds Open and the Effective ... Even OIS has its weaknesses. Like LIBOR it is unsecured. And the Fed Funds market is much less liquid now that the FRB pays 25bp on reserves and the FDIC includes it when calculating insurance fees. We wonder if repo on ‘safe assets’ wouldn’t be better?”
Diamond appeared before the UK Treasury Select Committee after he resigned from his post on 3 July in the aftermath of the LIBOR scandal, which has rocked British banking.
Financial institutions contribute rates that are used in the calculation of LIBOR and EURIBOR. The contributed rates are supposed to reflect each bank’s assessment of the rates at which they can borrow unsecured interbank funds.
For LIBOR, the highest and lowest 25 percent of contributed rates are excluded from the calculation and the remaining rates are averaged to calculate the fixed rates. For EURIBOR, the highest and lowest 15 percent are excluded and the remaining 70 percent are averaged to calculate the fixed rates.
Futures, options, swaps, and other derivative financial instruments traded in OTC markets and on exchanges worldwide are settled based on LIBOR, and mortgages, credit cards, student loans and other consumer lending products often use LIBOR as a reference rate.
According to reports, between 2005 and 2007, and then occasionally through 2009, certain Barclays traders requested that the Barclays LIBOR and EURIBOR submitters contribute rates that would benefit the financial positions held by those traders.
Traders in New York and London made the requests via electronic messages, as well as telephone and face-to-face conversations. The employees responsible for the LIBOR and EURIBOR submissions accommodated those requests on numerous occasions in submitting the bank’s contributions. On some occasions, Barclays’s submissions affected the fixed rates.
On top of Diamond’s resignation, Barclays’s board has agreed to an audit of its business practices. It has paid the US Department of Justice a $160 million penalty to resolve violations. The US Commodity Futures Trading Commission (CFTC) has ordered Barclays to pay $200 million, and the UK Financial Services Authority (FSA) fined Barclays £59.5 million for misconduct, which is the largest fine ever imposed by the FSA.
But the bank’s co-operation with the FSA entitles it to a 30-percent discount under the FSA’s settlement discount scheme, and the Department of Justice’s assistant attorney general Lanny Breuer said that the bank took a significant step towards accepting responsibility for its conduct by being the first institution to provide extensive and meaningful cooperation to the government.
Tracey McDermott, the acting director of enforcement and financial crime at the FSA, said: “Barclays’ misconduct was serious, widespread and extended over a number of years. The integrity of benchmark reference rates such as LIBOR and EURIBOR is of fundamental importance to both UK and international financial markets. Firms making submissions must not use those submissions as tools to promote their own interests.”
“The BBA [British Bankers’ Association] is currently undertaking a review of the way LIBOR is set and will publish its findings shortly. The FSA, along with the other tripartite authorities, is working to support market-led reviews of existing arrangements, with the goal of ensuring such arrangements continue to command the confidence of all stakeholders.”
Breuer called LIBOR and EURIBOR “critically important benchmark interest rates”, but some financial industry professionals have called for the most prevalent benchmark rates to be reassessed. The BBA, which has overseen LIBOR for 26 years, is working with the government and regulators to abolish rate manipulation.
In a recent blog post, Jonathan Cooper, senior consultant at securities and investment research firm Finadium, said LIBOR has a major weakness that needs addressing.
He said: “For LIBOR there aren’t actual trades being reported—only an estimate of where it might trade. It is a major weakness. LIBOR had already lost its effectiveness as a short-term benchmark. It isn’t only the manipulation scandal that has done it in. During the financial crisis the market found out the hard way just how much credit risk was embedded in LIBOR. When OIS spreads were narrow, it didn’t matter much. But when they blew out ... the situation changed completely. Inefficient forwards, a result of the credit risk, made LIBOR useless.”
“Acknowledging that LIBOR was not an appropriate rate, broker/dealers and clearinghouses like LCH.Clearnet started discounting swaps, for mark to market purposes, using OIS curves. At least OIS is linked to the Fed Funds effective ... which is a rate that is both observable and executable, save for some basis risk between Fed Funds Open and the Effective ... Even OIS has its weaknesses. Like LIBOR it is unsecured. And the Fed Funds market is much less liquid now that the FRB pays 25bp on reserves and the FDIC includes it when calculating insurance fees. We wonder if repo on ‘safe assets’ wouldn’t be better?”
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