Assignment - Case study: The LIBOR scandal
The LIBOR (London Interbank Offered Rate), was established in 1986 with the purpose of providing fair and standardised interest rates for loans and borrowing between banks around the world (Gilligan n.d.; Dooley 2012; Alessi & Sergie 2013), and it has since become the most frequently used short-term interest rate benchmark. How it works is that the daily rate is obtained from collecting interest rate data from the different international banks, and then in an attempt to eliminate the risk to the reliability with regard to the rate, the top 25% and bottom 25% of rates are discarded. From there the average of the left over rates is obtained, and published as the the daily rate (MacKenzie 2008; Dooley 2012; Alessi & Sergie 2013). The benchmarks are calculated across ten currencies and fifteen maturities, and are based on submissions from LIBOR member banks (Gilligan n.d.; Dooley 2012), some of whom operate in all the currencies (Dooley 2012).
The responsibility for the administration of the LIBOR has traditionally rested with the British Bankers' Association, so that it is operated with no government oversight (Dooley 2012). However, in July 2013, as a result of a scandal involving the collusion of many banks in manipulating the rate in order to benefit their position, the function was transferred to the New York Stock Exchange (NYSE) Euronext, in an effort to reinstate the integrity of the process (Douglas 2013). The effect of the LIBOR scandal cannot be underestimated, as the LIBOR involves hundreds of trillions of dollars in the banking system; that sort of money well and truly has the ability to affect the integrity of the global banking system (Touryalai 2012; MacKenzie 2008). So far, 20 banking institutions have been investigated with regards to the scandal ('The LIBOR scandal: The rotten heart of finance '2012) and, as time passes, the shortcomings of regulators have also been discovered.
What were the motivations behind the banks' rigging of the LIBOR rate? Barclays, and indeed most of the institutions involved, seemed to have two reasons for doing so. The first was to make their position seem healthier during the Global Financial Crisis (GFC) (Touryalai 2012; Dooley 2012); that is, if the rates published had reflected their position accurately and truly, then their borrowing capacity would have decreased and their borrowing costs would have increased. Ironically, the transparency of the rate setting created an environment in which lying was seen as a fundamental tool to surviving the GFC, and given many banks were involved in the scandal, the majority must have been complicit with none willing to point the finger at others ('The LIBOR scandal: The rotten heart of finance' 2012). The second was to benefit from derivatives trades during both the economic upswing and conversely during the GFC (Dooley 2012; 'The LIBOR scandal: The rotten heart of finance' 2012; Alessi & Sergie 2013).
The main regulators involved in the LIBOR scandal are the Financial Services Authority (FSA) in the UK, the US Commodity Futures Trading Commission (CFTC) and the US Department of Justice (Armour n.d.). In the case of UBS (a Swiss bank), there were Swiss regulators. Also regulators from most first world countries are investigating the scandal. When the scandal broke, regulators indicated that financial settlements as reparation to the regulators would be based on both the reason and method of manipulation used by each of the banks involved (Touryalai 2012), although there are indications that regulators may have not been on the front foot with regard to instigating reforms which might have buffered the scandal from occurring in the first instance. Examples of this include the New York Federal Reserve, which sent the Bank of England a letter in 2008 making recommendations to improve the credibility of LIBOR's reporting system; the New York Federal Reserve did not follow the letter up (Alessi & Sergie 2013). Additionally, during the GFC, the Bank of England may have actually instructed Barclays to deliberately lower their rates in order to defend the position of British banks within the market ('The LIBOR scandal: The rotten heart of finance 2012').
Some concerns have also been flagged regarding the Foreign Exchange and Money Markets Committee (FMXX). They establish guidelines for calculating the LIBOR and select the banks serving on the panels, however there have been concerns regarding the lack of transparency around FXMM, which has bought into question their objectivity and independence (Dooley 2012).
The cost of the LIBOR scandal to the banking community has been immense, as the banking sector's already somewhat tarnished reputation has received further scrapes, especially given that the manipulations were seen as based on self-interest and greed. It is not only the banking sector as a whole that has suffered, but also individual banks. On 27 June 2012, Barclays Bank paid regulators $450 million in fines relating to their role with manipulating the LIBOR (Armour n.d.). The next day, Barclay's stock tumbled by 15%. This stock price drop represented a far greater sanction than the fines placed by the regulators. Although some of the market capitalisation decline was somewhat a reaction to likely lawsuits, it also reflects the public sentiment regarding the bank's maleficence (Armour n.d.). On 2 July, Bob Diamond, CEO of Barclays, resigned, possibly trying to deflect the attention. Barclays' former Chairman, Marcus Agius, commented that once other banks settled with regulators, Barclays' involvement would not seem as disproportionate. This response may have indicated how normalised such behaviour was within the sector - which begs the question, exactly how much did regulators know (Gilligan n.d.)?
The next bank to settle with regulators was UBS, on 19 December 2012. They got hit with a $1.5 billion sanction from US, UK and Swiss regulators - a much larger financial slap than Barclays. The harshness of the penalty reflects not only UBS's attempts to manipulate the market to make the bank appear healthier, but collusion between at least four other panel banks, and more than 2000 unlawful conduct charges (Touryalai 2012). As Joaquin Almunia of the EU Competition Commission noted, it is unusual practice for competing businesses to collude ('Libor scandal: EU slap six banking giants with $2.3-billion fine' 2013), yet collude they did. One high-profile trader, Thomas Hayes, regularly colluded with others - with his manager's knowledge, no less. The express purpose here was to increase his desk's profitability and his personal bonus (Touryalai 2012; Alessi & Sergie 2013).
Another casualty of the LIBOR rigging scandal was Rabobank, which was fined $1 billion by regulators. Thirty of its staff had attempted to manipulate the LIBOR and EURIBOR (Euro Interbank Offered Rate) benchmarks, and the outgoing Chief Executive, Piet Moerland, acknowledged that this behaviour contravened Rabobank's core values and integrity (Webb 2013). Further, Rabobank had failed to act when an employee informed them about such problems at an internal audit in 2009, and they had also reassured the British regulator in 2011 that they were operating within the boundaries of expectation (Webb 2013).
Ultimately, the largest penalty handed down by EU antitrust regulators amounted to US$2.3 billion and was imposed on six banks, including Deutsche Bank, Royal Bank of Scotland and Citigroup. This penalty reflected similar issues that had occurred in Barclays and UBS. The upward penalty swing seems to relate to Barclays and UBS' agreement to blow the whistle on the cartel, which earned them some measure of immunity from regulators, although it should be noted this does not offer them immunity in US courts from investor lawsuits, where damages of three times harm done can be claimed ('The LIBOR scandal: Fixed harmony' 2013).
The outflow of money for the banks involved does not cease with penalties from regulators - civil lawsuits will follow from clients (Webb 2013), and are estimated to cost $35 billion in settlements (Alessi & Sergie 2013). For example, in late September 2013, Fannie Mae filed a lawsuit against nine big banks who they allege colluded and led to Fannie Mae incurring losses as a result of the LIBOR rate manipulation (Douglas 2013). Many more lawsuits are expected to be filed by pension funds, asset managers, etc. Interestingly, Fannie Mae has also sued the British Bankers' Association who collated the LIBOR data daily.
Further tightening of the sector is anticipated. A review of the LIBOR, the Wheatley Review, was released on 28 September 2012, with the UK's Financial Secretary to the Treasury confirming the recommendations would be implemented in full in October of the same year, and other international regulators evaluating the report with consideration to improving the integrity and public trust of the LIBOR (Dooley 2012). It seems that the general consensus now is to retain the LIBOR in a modified form. It will be interesting to see what adjustments are made to the system, and how the banks react to the changes, given how well the existing system served them until the LIBOR scandal hit - perhaps the regulator fines and lawsuits will give them pause for thought.
Questions
1. Identify at least three ethical issues that arise in this case.
2. 'The traders' ability to impact the interest rate benchmark represents a conflict of interest.' Discuss.
3. Examine the behaviour and possible intent of traders in this case. How does it compare to the concepts and standards of a true profession?
4. Apply the following theories to the LIBOR scandal and outline how the theory applies to this case: (a) utilitarianism (b) deontology and (c) virtue ethics (Salazar 2013).
5. Are the banks who employ these traders accountable or are these simply individuals acting on self-interest?
6. What can the financial institutions do to regain trust?
Attachment:- Assignment.rar