Libor Gate

7/31/2019 Libor Gate

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LIBOR & LIBORGATE

Recently there was a news that Barclays would pay $453 million to U.S. and British authoritiesto settle allegations that it had manipulated LIBOR , a benchmark interest rate that affects some$350 trillion worth of financial transactions. The scandal has since spread to implicate major

banks and government regulators around the world, and could be one of the most expensive tohit the financial industry since the 2008 financial crisis.

Now the questions which arises in our mind are What is LIBOR exactly?, How it is calculated?,How did Barclays manipulate LIBOR etc.

LIBOR IN BRIEF

LIBOR is an acronym for the London Interbank Offered Rate, a benchmark interest rate that ispublished daily. Libor is published under the auspices of the British Bankers Association(BBA),a trade association with over 200 member banks that addresses issues involving the

United Kingdom banking and financial services industries. The BBA defines LIBOR as:

The rate at which an individual Contributor Panel bank could borrow funds, were it to doso by asking for and then accepting inter-bank offers in reasonable market size, just priorto 11:00 [a.m.] London time.

We can also define LIBOR as an indicative average interest rate at which a selection of banks(the panel banks) are prepared to lend one another unsecured funds on the London moneymarket. Investors around the world use the LIBOR to calculate the interest rate on myriad formsof debt, from home mortgages and credit cards to municipal bonds and derivatives contracts. TheCommodity Futures Trading Commission, which doggedly pursued the wrongdoing and brought

the scandal to light, estimates that some $350 trillion worth of derivatives and $10 trillion worthof loans are based on LIBOR.

LIBOR CALCULATION

The LIBOR interest rates are not based on actual transactions. On every working day at around11 a.m. (London time) the panel banks inform Thomson Reuters for each maturity at whatinterest rate they would expect to be able to raise a substantial loan in the interbank moneymarket at that moment. The reason that the measurement is not based on actual transactions isbecause not every bank borrows substantial amounts for each maturity every day. Once ThomsonReuters has collected the rates from all panel banks, the highest and lowest 25% of value are

eliminated. An average is calculated of the 50% remaining mid values in order to produce theofficial LIBOR rate. Suppose there are 16 banks in the panel which submitted their estimatedrate for each maturity to Thomson Reuters. Now out of this lowest four rates (lowest 25%) andhighest four rates(highest 25%) would be eliminated. Average of remaining eight rates iscalculated and published as the LIBOR for the day.


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LIBOR CURRENCIES

At present LIBOR interest rates for ten currencies are calculated. This currencies are -:

American dollar - USD LIBOR

Australian dollar - AUD LIBORBritish Pound Sterling - GBP LIBORCanadian dollar - CAD LIBORDanish krone - DKK LIBOREuropean euro - EUR LIBORJapanese yen - JPY LIBORNew Zealand - NZD LIBORSwedish krona - SEK LIBORSwiss franc - CHF LIBOR

LIBOR MATURITIES

LIBOR rates are calculated for 15 different maturities. These are :-

One dayOne weekTwo weeksOne monthTwo monthsThree monthsFour monthsFive monthsSix monthsSeven monthsEight monthsNine monthsTen monthsEleven monthsTwelve months

LIBOR MANUPULATIONS BY BARCLAYS

LIBOR works on a kind of honor code, so the manipulation part is fairly simple: Barclaysreported a lower interest rate than it actually was paying. Barclays' alleged motive was to securecheaper loans and to make itself appear healthier during the financial turmoil than it actuallywas.


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The basis for a Contributor Panel banks submission, according to the BBA, must be the rate at

which members of the banks staff primarily responsible for management of a banks cash, ratherthan a 2banks derivative trading book, consider that the bank can borrow unsecured inter banksfunds in the London money market. Further according to the BBA, a Contributor Panel bank

may not contribute a rate based on the pricing of any derivative financial instrument. In otherwords, a Contributor Panel banks LIBOR submissions should not be influenced by its motive tomaximize profit or minimize losses in derivative transactions tied to LIBOR. Barclays did theexact opposite.

Within Barclays LIBOR rate where manipulated through two different ways :-

Swaps Traders Requests Within BarclaysInterbank Swaps Trader Requests

Swaps Traders Requests Within Barclays

From approximately 2005 through 2007, and occasionally thereafter through approximately2009, certain Barclays swaps traders requested that certain Barclays LIBOR submitters submitLIBOR contributions that would benefit the traders trading positions, rather than rates that

complied with the definitions of LIBOR. Those swaps traders either proposed a particularLIBOR or contribution for a particular tenor and currency, or proposed that the rate submittercontribute a rate higher, lower, or unchanged for a particular tenor and currency. The swapstraders made these requests via electronic messages, telephone conversations, and in-personconversations. The LIBOR submitters agreed to oblige, and obliged, the swaps traders requestsfor favorable LIBOR submissions on numerous occasions.

In the instances when the published rates were manipulated in Barclayss favor due to Barclayss

manipulation of its submissions, that manipulation benefitted Barclays swaps traders, orminimized their losses. Certain Barclays swaps traders and rate submitters who engaged inefforts to manipulate LIBOR submissions were well aware of the basic features of the derivativesproducts tied to these benchmark interest rates; accordingly, they understood that to the extentthey increased their profits or decreased their losses in certain transactions from their efforts tomanipulate rates, their counterparties would suffer corresponding adverse financial consequenceswith respect to those particular transactions.

Interbank Swaps Trader Requests

From at least approximately August 2005 through at least approximately May 2008, CertainBarclays swaps traders made requests of traders at other Contributor Panel banks for favorableLIBOR submissions from those banks. In addition, certain Barclays swaps traders receivedrequests from traders at other banks for favorable LIBOR submissions from Barclays ratesubmitters. When Barclays swaps traders did not have trading positions conflicting with their


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counterparts requests, those Barclays swaps traders sometimes would agree to request a LIBORsubmission from the Barclays LIBOR submitters that would benefit their counterpartspositions. Those interbank communications included ones in which certain Barclays swapstraders communicated with former Barclays swaps traders who had left Barclays and joinedother financial institutions. The likelihood that the LIBOR fix would be affected increased when

other Contributor Panel banks also manipulated their submissions as part of a coordinated effort.

POSSIBLE VICTIMS OF THE SCANDAL :

The time period when this whole scandal took place can be divided in to two phases :

Phase 1Phase2

Phase1 (2005 -2007)

Before the financial crisis , there is serious evidence that swap traders regularly requested forhigher LIBOR rates so as to make extra bucks. It wasn't one conspiracy, but many differentpeople trying to influence specific bets they made on LIBOR. These were likely small changes,but with billion dollar bets hanging in the balance around the world, it could mean a lot.According to rough estimate LIBOR affects close to $350 trillion of financial transactionsthroughout the world. So even 1% of change can means $3.5 trillion of illegal movements.

If Barclays traders managed to get the rates higher before the financial crisis, as they requested,then consumers suffered. All the consumers who had loans i.e. right from educations loans tohome loans that was based on LIBOR might have a slightly higher rate. Its hard to tell at thispoint just how much rates changed, but it's a possibility.

Phase2 (2007-2009)

During this period when the whole world was engulfed with financial crisis , Barclays throughthe manipulation of LIBOR reported low borrowing interest rates. This was used to given signalto the investors that bank is doing good in tough times.

When the rate was going down during the crisis, consumers might have gotten better deals ontheir loans. But that doesn't mean we should celebrate. A lot of cities and pension funds andtransportation systems had money in LIBOR based investments. They would have made a lotless money if LIBOR was manipulated down. The City of Baltimore, for instance, is suing andclaims to have lost millions of dollars in the manipulation.

One thing that took hit for sure due to the revelation of this scathing manipulation is thereputation of financial institutes. And it will take huge effort on the part financial institutions togain same level of trust as before the scandal.


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INVESTIGATION AND ITS PROGRESS

The first major milestone as far as investigation is concerned was when The U.S. CommodityFutures Trading Commission (CFTC) Ordered Barclays to pay $200 Million Penalty forAttempted Manipulation of and False Reporting concerning LIBOR benchmark interest rates.According to the Order, Barclays, through its traders and employees responsible for determiningthe Banks LIBOR submissions (submitters), attempted to manipulate and made false reportsconcerning both benchmark interest rates to benefit the Banks derivatives trading positions by

either increasing its profits or minimizing its losses. The Order also finds that throughout theglobal financial crisis in late August 2007 through early 2009, as a result of instructions fromBarclays senior management, the Bank routinely made artificially low LIBOR submissions toprotect Barclays reputation from negative market and media perceptions concerning Barclays

financial condition. In addition to this Barclays paid $160 million to the U.S Justice Department

and close to $93 to British Authorities. Barclays chief executive Bob Diamond and chiefoperating officer Jerry del Missier resigned after the coming of CFTC orders.

The U.S. Justice Department is reportedly considering bringing criminal charges against severalU.S. banks. Citigroup is also a target of investigation. Earlier this year, it emerged that a fewtraders at Citigroup and UBS tried to manipulate Libor rates for the Yen . The Times of Londonreported that Royal Bank of Scotland could soon be hit with a fine of up to $150 million forrelated charges.

The framing of charges and court orders against Barclays is only the tip of iceberg. Many morerevelations to come in future as the investigation progresses.

REFERENCES

http://theweek.comhttp://www.npr.orghttp://www.corporatecrimereporter.comhttp://www.nytimes.comhttp://www.global-rates.com


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Rahul Kaushik

PGDIM 19 NITIE

9769758507

Author did his engineering from School Of Engineering, CUSAT, Kochi, Kerala. He worked forTCS for close to two years. Currently he is first year student in PGDIM program in NITIE.


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Libor Gate

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