March 11, 2012 8:13 pm
Global interest rates: Libor – a benchmark to fix
An investigation into how key financial reference points are set has put some banks in the spotlight
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“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?”
Every day, employees at the world’s leading banks are asked an inelegantly worded question used to calculate the benchmark rates that help determine the price of mortgages, the cost of corporate lending and the interest added to credit card bills.
Their answers are now at the heart of a sprawling regulatory investigation into possible manipulation of the London interbank offered rate, one of the most important reference points of the global financial system.
At least 10 enforcement agencies in the US, Canada, Europe and Japan are examining whether bankers and brokers colluded to rig Libor – the index interest rate used for $350tn worth of financial products – and other widely watched rates to boost profits from their in-house trading positions.
For 18 months, officials have been scrutinising whether some banks, through electronic bids processed in London, submitted artificially low Libor numbers to mask their own mounting financial difficulties as a worldwide credit crisis deepened in late 2007 and 2008.
The probe, in which investigators are still sorting through allegations of criminal intent and regulatory shortfalls, has threatened the best efforts of the banking industry to draw a line under the crisis, which led to taxpayers bailing out the financial system. Proved manipulation of index rates could expose banks to a legal and regulatory bonanza, from big fines to class action lawsuits, several of which have already been filed.
“Any confirmed manipulation of these interest rates would imply a very significant cost to the European economy,’’ Joaquín Almunia, European Union competition commissioner, said last month.
Three of the world’s biggest banks – UBS, Citigroup and Barclays – have voluntarily approached regulators with information about possible abuse of the rate-setting process by current and former staff. More than a dozen employees at other institutions, including JPMorgan Chase, Deutsche Bank, Royal Bank of Scotland, HSBC and the interdealer brokers Icap and RP Martin, have been fired, suspended or placed on administrative leave in recent months as the investigation gathers pace.
In Canada, court filings by local competition officials have publicly documented a scheme allegedly used to rig a Libor rate, masterminded by a small group of traders. In Tokyo, Japanese financial regulators have taken action against UBS and Citi over attempts by former employees to “influence” benchmark rates, while in a Singapore court case, a former trader at Royal Bank of Scotland has claimed that requests for certain Libor rates were “regularly made” by employees in recent years to maximise profit.
As investigators probe to see whether a process designed to be impervious to manipulation has been purposefully subverted, the British Bankers’ Association, a trade group that sponsors Libor, last week launched a comprehensive review, acknowledging that the way the rate is set may need updating.
“We are committed to the continuing and ongoing evolution of Libor as appropriate,” says Angela Knight, the BBA’s chief executive.
Prior to the current inquiry, the relatively old-fashioned mechanism used to fix Libor and other benchmark interest rates was of interest only to market practitioners and a small cadre of critics, who argued that it was a poor gauge of banks’ actual borrowing behaviour.
At their simplest level, Libor, Tibor and Euribor, as the main rates are known, are supposed to be daily measures of how much banks are paying to borrow from one another in dollars, euros, yen and other currencies for set lengths of time, ranging from overnight to 12 months.
The rate-setting process, largely unchanged for 26 years, offers a crucial indicator of the overall health of the financial system. A jump in Libor can signal that banks are increasingly reluctant to lend to each other – one of the contributing factors in the credit crisis. Libor also serves as the underlying reference for the interest paid on scores of everyday financial products. The average US adjustable rate mortgage, for example, is indexed to Libor, with a premium of 2-3 percentage points tacked on.
Because the rates are based on banks’ own estimates as opposed to actual loan data, critics have long argued that at times of financial stress, lenders have an incentive to “low-ball” their submission in order to appear healthier.
The Libor investigation has attracted attention in part because it upends a basic assumption of how the market functions. Bankers argue that even if individual traders try to co-ordinate their quotes, the algorithm used to calculate the rate should make it impossible for them to succeed in moving the benchmark index enough to profit from it.
Regulators are piecing together a mosaic of information about how Libor and other rates may have been targeted. No individual has been charged with wrongdoing, and officials involved with the case in different countries caution that fines or other penalties are not imminent.
In some areas, multiple enforcement agencies are co-operating, such as the US Department of Justice, the Federal Bureau of Investigation and the Commodity Futures Trading Commission.
Several lawyers representing individuals involved say, however, that the inquiry is neither as advanced nor as globally orchestrated as some suggest. “As far as I can see, you have two or three regulators floundering around with no co-ordination,” says one UK-based lawyer.
Some banks have been co-operating with regulators – in effect blowing the whistle on their own employees in the hope of securing leniency from future enforcement actions. Their statements, found in court documents and releases, have helped flesh out some of the contours of the multi-pronged investigation.
Barclays, for example, came forward to the European Commission and the UK’s Financial Services Authority after uncovering internal communications that suggested former employees may have breached internal “Chinese walls” barring information-sharing between traders and the bank’s rate-setters for Euribor, say two people with direct knowledge of the case.
Philippe Moryoussef, a derivatives trader who left the bank in 2007 and now works at Nomura in Singapore, is one of the former employees being investigated, those people said. He did not respond to requests for comment.
On Friday, Barclays revealed in its annual report that it had been informed by unnamed authorities that it may face regulatory action relating to the probe, and that it was “engaged in discussion with those authorities about potential resolution’’.
A separate but similar development came in the summer of 2010 at Citigroup’s London office. Employees raised concerns about what they saw as attempts by Thomas Hayes, a senior trader in Tokyo, to alter the bank’s daily bids for yen-denominated Libor, according to six people familiar with the case who asked not to be named, citing the sensitivity of the case.
Having recently joined Citi from UBS, Mr Hayes was billed as a star hire who would transform Citi’s fortunes in Japan following a series of clashes with local regulators.
Hired by Christopher Cecere, the former head of rates trading for developed countries in Asia, Mr Hayes had been a big money-maker for UBS, according to people familiar with his employment.
Within less than a year, however, both Mr Hayes and Mr Cecere had left Citi after they were accused in an internal investigation of attempting to influence yen Libor or the separate Tokyo interbank offered rate (Tibor), according to current and former Citi executives with direct knowledge of the investigation.
Instead of attracting big profits, the two men’s trading positions were unwound at a more than $50m loss after they left. At the time, Citi executives say, the trading irregularities seemed both isolated and unusual.
One former senior banker at the US group who was briefed at the time about Mr Hayes’ and Mr Cecere’s actions said colleagues were mystified at what appeared to be an attempt to influence the rate: “It seemed an incredibly dumb thing to do.”
Mr Hayes has not responded to repeated attempts by the Financial Times to contact him directly and through his lawyer. Mr Cecere, who now works for the hedge fund Brevan Howard in Geneva, has told the FT that he was never questioned by regulators and left the bank in good standing.
Japanese regulators barred Citi in December last year from conducting derivatives transactions related to Tibor and yen Libor for 13 days over its failure to prevent the inappropriate approaches to rate-setting staff.
In an official finding by Japan’s Securities and Exchange Surveillance Commission, the regulator said an employee known as “Trader B” had begun targeting Citi staff who submitted yen Libor quotes beginning in December 2009, repeatedly asking them to change the figures. By April 2010, an executive known as “Director A” had been “continuously conducting” similar approaches to Citi employees who submitted the bank’s quotes for Tibor, the SESC found.
The agency has declined to identify the two men publicly. But six people with direct knowledge of the case have confirmed to the FT that “Trader B” is Mr Hayes and “Director A” is Mr Cecere.
When staff in Tokyo rebuffed the traders’ approaches, Mr Hayes and Mr Cecere contacted rate setters in London, according to people familiar with the case. London employees reported their approaches to internal compliance supervisors, those people say.
Regulators are scrutinising Mr Hayes’ activities at UBS before his move to Citi in 2009, according to public filings and people familiar with the investigation.
Like Citi, UBS was subject to official action by Japanese regulators in December over attempts by a former trader to influence the bank’s rate setters for Tibor and yen Libor from 2007 onwards. While the trader is referred to only as “Trader A’’ in those documents, six people familiar with the case said it was Mr Hayes.
The Swiss banking group, having lurched from crisis to crisis in recent years, including an alleged $2.3bn rogue-trading scandal, was the first bank to disclose the existence of a global Libor probe in March 2011. It was also the first to come forward to several regulators with detailed information about potential abuse of the rate-setting process by current and former employees.
Last July, the group revealed it was co-operating with regulators in the US and Japan in exchange for partial immunity over the potential manipulation of yen Libor and Tibor. As the investigation has widened, UBS has suspended some of its most senior traders in Zurich.
Recently filed documents in the Ontario Superior Court by the Canadian Competition Bureau, which is looking at whether Canadian consumers were harmed by the alleged rigging of benchmark borrowing rates, provide the most detailed roadmap yet as to how traders and interdealer brokers may have worked together to manipulate yen Libor.
According to a sworn affidavit from one of the lead investigators in that case, employees at an unnamed bank “were able to move yen Libor rates to the overall net benefit by the participants” by working with interdealer brokers and traders at rival banks in London including HSBC, Deutsche Bank, RBS, JPMorgan Chase and Citi.
In one instance, an employee identified as “Trader A” told an interest rates trader at HSBC “his trading positions, his desire for a certain movement in yen Libor, and instructions for the HSBC trader to get HSBC to make yen Libor submissions consistent with his wishes”, according to an affidavit sworn on May 18 2011 by Brian Elliott, a Canadian law officer.
UBS is not identified in that lawsuit but three people with direct knowledge of the case say it is the institution that provided information about the attempted manipulation of yen Libor. UBS and other banks named in the case declined to comment.
Lawyers and regulatory officials involved with the case warn that the scheme detailed in the Canadian court documents is just one part of a wide-ranging investigation and is not the core focus of enforcement agencies in other jurisdictions.
Traders and brokers who have been suspended or named in various filings may be “people of interest” – those who may have seen rather than participated in any sort of rate fixing – who can help elucidate the scale of the alleged problem, those people say.
“We could,” admits one UK lawyer working on the case, “be just at the tip of the iceberg.”
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London’s rate retains the edge
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In the 1980s, companies were just beginning to use futures contracts to hedge their interest rate risks and London was emerging as a centre for loan syndication. Both markets, however, were hampered by a lack of standard reference rates.
So they turned to the British Bankers’ Association, the leading trade grouping for financial services, and the Bank of England for help. By 1986, their efforts had morphed into Libor, the London interbank offered rate, for dollars, yen and sterling.
Libor rates are now calculated in 10 currencies with 15 maturities for each currency and have been supplemented internationally by Tibor, the Tokyo-based rate for yen, and Euribor, set in Brussels for euros. In each case, the rates are set by getting estimates from panels of banks, dropping the top and bottom few and taking a trimmed average. But the process has come under criticism from academics and market participants since the financial crisis started in 2007. At that time, bank estimates for Libor began varying widely from one another, particularly for US dollars, and the short-term rates visibly diverged from overnight indexed swaps (OIS), which are tied to actual market transactions.
The BBA responded by adding more banks to its dollar panel and by improving governance with an independent board in 2008. The grumbling has not stopped, however, and the hunt is on for better indices.
So far, traders say, Libor still has the edge, particularly for lending longer than a month, because there simply are not any good alternatives. But the stakes for the BBA’s latest review of Libor, announced last week, remain high. If market participants are not satisfied that the governance and integrity issues have been solved, $350tn in financial products could be looking for a new benchmark.
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Copyright The Financial Times Limited 2012
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