Libor Lies Revealed in Rigging of $300 Trillion Benchmark

Libor Lies Revealed in Rigging of $300 Trillion Benchmark

By Liam Vaughan & Gavin Finch -
Jan 28, 2013 3:54 PM CT


Bloomberg Markets Magazine





The benchmark rate for more than $300 trillion of contracts was based on
honesty. New evidence in banking's biggest scandal shows traders took
it as a license to cheat. Graphic: Bloomberg Markets





Every morning, from his desk by the bathroom at the far
end of Royal Bank of Scotland Group Plc’s trading floor overlooking
London’s Liverpool Street station, Paul White punched a series of
numbers into his computer.
















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Former Barclays CEO Robert Diamond gave evidence to the Treasury Select
Committee in London on July 10, 2012. Diamond stepped down from his position
after regulators fined the bank 290 million pounds for attempting to rig the
benchmark interest rate. Photographer: Paul Thomas/Bloomberg










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Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission,
started an investigation after listening to a tape of a conversation between
traders and rate setters at Barclays. Photographer: Peter Foley/Bloomberg










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Stephen Rosen, an attorney at Collyer Bristow in London, represents a real
estate company, three nursing homes and more than a dozen other firms that
bought Libor-linked interest-rate swaps from banks. Photographer: Harry Borden/ Bloomberg Markets










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White, who had joined RBS
in 1984, was one of the employees responsible for the firm’s submissions
for the London interbank offered rate, or Libor, the global benchmark
for more than $300 trillion of contracts from mortgages and student
loans to interest-rate swaps. Behind him sat Neil Danziger, a
derivatives trader who had worked at the bank since 2002.
On the
morning of March 27, 2008, Tan Chi Min, Danziger’s boss in Tokyo, told
him to make sure the next day’s submission in yen would increase,
Bloomberg Markets magazine will report in its March issue. “We need to
bump it way up high, highest among all if possible,” Tan, who was known
by colleagues as Jimmy, wrote in an instant message to Danziger,
according to a transcript made public by a Singapore court and reported
on by Bloomberg before being sealed by a judge at RBS’s request.

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Danziger
typically would have swiveled in his chair, tapped White on the
shoulder and relayed the request to him, people who worked on the
trading floor say. Instead, as White was away that day, Danziger input
the rate himself. There were no rules at RBS and other banks prohibiting
derivatives traders, who stood to benefit from where Libor was set,
from submitting the rate -- a flaw exploited by some traders to boost
their bonuses.

The next morning, RBS said it would have to pay
0.97 percent to borrow in yen for three months, up from 0.94 percent
the previous day. The Edinburgh-based bank was the only one of 16
surveyed to raise its submission that day, inflating that day’s rate by
one-fifth of a basis point, or 0.002 percent. On a $50 billion portfolio
of interest-rate swaps, RBS could have gained as much as $250,000.
Events
like those that took place on RBS’s trading floor, across the road from
Bishopsgate police station and Dirty Dicks, a 267-year-old pub, are at
the heart of what is emerging as the biggest and longest-running scandal
in banking history. Even in an era of financial deception -- of firms
peddling bad mortgages, hedge-fund managers trading on inside
information and banks laundering money for drug cartels and terrorists
-- the manipulation of Libor stands out for its breadth and audacity.
Details are only now revealing just how far-reaching the scam was.
“Pretty
much anything you could do to increase the revenue of your organization
appeared legitimate,” says Martin Taylor, chief executive officer of
London-based Barclays Plc from 1994 to 1998. “Here was the market doing
something blatantly dishonest. I never imagined that people in the
financial markets were saints, but you expect some moral standards.”
Where
Libor is set each day affects what families pay on their mortgages, the
interest on savings accounts and returns on corporate bonds. Now, banks
are facing a reckoning, as prosecutors make arrests, regulators impose
fines and lawyers around the world file lawsuits claiming the
manipulation pushed homeowners into poverty and deprived brokerage firms
of profits.
For years, traders at Deutsche Bank AG, UBS AG,
Barclays, RBS and other banks colluded with colleagues responsible for
setting the benchmark and their counterparts at other firms to rig the
price of money, according to documents obtained by Bloomberg and
interviews with two dozen current and former traders, lawyers and
regulators. UBS traders went as far as offering bribes to brokers to
persuade others to make favorable submissions on their behalf,
regulatory filings show.
Members of the close-knit group of
traders knew each other from working at the same firms or going on trips
organized by interdealer brokers, which line up buyers and sellers of
securities, to French ski resort Chamonix and the Monaco Grand Prix. The
manipulation flourished for years, even after bank supervisors were
made aware of the system’s flaws.
“We will never know the amounts
of money involved, but it has to be the biggest financial fraud of all
time,” says Adrian Blundell-Wignall, a special adviser to the
secretary-general of the Organization for Economic Cooperation and
Development in Paris. “Libor is the basis for calculating practically
every derivative known to man.”
More than five years after alarms
first sounded, regulators and prosecutors are closing in. UBS was fined a
record $1.5 billion by U.S., U.K. and Swiss regulators in December for
rigging global interest rates. Tom Hayes, 33, a former yen trader at the
Zurich-based bank, was charged by the U.S. Justice Department on Dec.
20 with wire fraud and price fixing for colluding with brokers, contacts
at other firms and his colleagues to manipulate Libor. Hayes hadn’t
entered a plea as of mid-January, and his lawyers at Fulcrum Chambers in
London declined to comment.
Barclays paid a 290 million pound
($464 million) fine in June to settle with regulators, and three top
executives, including CEO Robert Diamond, departed. Other banks,
including RBS, were negotiating settlements in early 2013, according to
people with knowledge of the talks. RBS may pay as much as £500 million
to settle allegations that traders tried to rig interest rates, two
people with knowledge of the matter say. UBS and Barclays admitted
wrongdoing as part of their settlement agreements. Spokesmen for the two
banks, and for RBS, declined to comment.
The industry faces
regulatory penalties of at least $8.7 billion, according to Morgan
Stanley analysts. The European Union is leading a probe that could see
banks fined as much as 10 percent of their annual revenue. Meanwhile,
Libor is being overhauled after the U.K. government ordered a review in
September into the way the benchmark is set.
The scandal
demonstrates the failure of London’s two-decade experiment with
light-touch supervision, which helped make the British capital the
biggest securities-trading hub in the world. In his 10 years as
chancellor of the Exchequer, from 1997 to 2007, Gordon Brown championed
this approach, hailing a “golden age” for the City of London in a June
2007 speech. Brown, who later served as prime minister for three years,
declined to comment.
Regulators have known since at least August
2007 that some banks were using artificially low Libor submissions to
appear healthier than they were. That month, a Barclays employee in
London e-mailed the Federal Reserve Bank of New York, questioning the
numbers that other banks were inputting, according to transcripts
published by the New York Fed. Nine months later, Tim Bond, then head of
asset allocation at Barclays’s investment bank, publicly described
Libor as “divorced from reality,” saying in a Bloomberg Television
interview that firms were routinely misstating their borrowing costs to
avoid the perception they were facing stress.
The New York Fed and
the Bank of England say they didn’t act because they had no
responsibility for oversight of Libor. That fell to the British Bankers’
Association, the industry lobbying group that created the rate in 1986
and largely ignored recommendations from central bankers after 2008 to
change the way it was computed. Regulators also were preoccupied with
the biggest financial crisis since the Great Depression, and forcing
banks to be honest about their Libor submissions might have revealed
they were paying penalty rates to borrow, which in turn would have
further damaged public confidence.
Libor is calculated daily
through a survey of banks asking how much it costs them to borrow in 10
currencies for periods ranging from overnight to one year. The top and
bottom quartiles of quotes are excluded, and those left are averaged and
made public before noon in London.
Because it’s based on
estimates rather than actual trade data, the process relies on the
honesty of participants. Instead of being truthful, derivatives traders
sought to influence their own and other firms’ Libor submissions, with
their managers sometimes condoning the practice, according to documents
and transcripts of instant messages obtained by Bloomberg.
Occasionally,
that meant offering financial inducements. “I need you to keep it as
low as possible,” a UBS banker identified as Trader A wrote to an
interdealer broker on Sept. 18, 2008, referring to six-month yen Libor,
according to transcripts released on Dec. 19 by the U.K.’s Financial
Services Authority.
“If you do that … I’ll pay you, you know, $50,000, $100,000 … whatever you want … I’m a man of my word.”
Some
former regulators say they were surprised to learn about the scale of
the cheating. “Through all of my experience, what I never contemplated
was that there were bankers who would purposely misrepresent facts to
banking authorities,” says Alan Greenspan, chairman of the U.S. Federal
Reserve from 1987 to 2006. “You were honorbound to report accurately,
and it never entered my mind that, aside from a fringe element, it would
be otherwise. I was wrong.”
Sheila Bair, who served as acting
chairman of the U.S. Commodity Futures Trading Commission in the 1990s
and as chairman of the Federal Deposit Insurance Corp. from 2006 to
2011, says the scope of the scandal points to the flaws of light-touch
regulation on both sides of the Atlantic. “When a bank can benefit
financially from doing the wrong thing, it generally will,” Bair says.
“The extent of the Libor manipulation was eye-popping.”
Libor
debuted the same year that British Prime Minister Margaret Thatcher’s
so-called Big Bang program of financial deregulation fueled a boom in
London’s bond and syndicated-loan markets. The rate was designed as a
simple benchmark that banks and borrowers could use to price loans.
In
1997, the Chicago Mercantile Exchange adopted the rate for pricing
Eurodollar futures contracts, solidifying Libor’s position in the swaps
market, which by June 2012 had a notional value of $639 trillion,
according to the Bank for International Settlements. Swaps are contracts
that allow borrowers to exchange a variable interest cost for a fixed
one, protecting them against fluctuations in interest rates.
The
CME decision created a temptation for swaps traders to game Libor,
particularly in the days before international money market dates, when
three-month Eurodollar futures settle. The value of positions was
affected by where dollar Libor was set on the third Wednesdays of March,
June, September and December. The manipulation of Libor was discussed
openly at banks.
“We have an unbelievably large set on Monday,”
one Barclays swaps trader in New York e-mailed the firm’s rate setter in
London on March 10, 2006. “We need a really low three-month fix. It
could potentially cost a fortune.” The rate setter complied with the
request, according to the FSA, which published the e-mail following its
investigation of the bank’s role in manipulating Libor.
The 2007
credit crunch increased the opportunity to cheat. With banks hoarding
cash and not lending to one another, there was little trading in money
markets, making it difficult for rate setters to assess borrowing costs
accurately. Instead, traders say they resorted to seeking input from
brokers, colleagues and acquaintances at other firms, many of whom stood
to benefit from helping to push the rate in a particular direction.
On
Aug. 20, 2007 -- days after BNP Paribas SA halted withdrawals from
three of its funds, which marked the start of the credit crisis -- Paul
Walker, RBS’s London-based head of money-markets trading, telephoned
Scott Nygaard in Tokyo, where he was head of short-term markets for
Asia. Walker, the person responsible for U.S.-dollar Libor submissions,
wanted to talk about how banks were using the benchmark to benefit their
trading positions.
“People are setting to where it suits their
book,” Walker said, according to a transcript of the call obtained by
Bloomberg. “Libor is what you say it is.”
"Yeah, yeah,” replied Nygaard, an American who had joined RBS in 2006 after six years at Deutsche Bank in Japan.
Walker
and Nygaard, who’s now global head of treasury markets based in London
and a member of the Bank of England’s money-markets liaison group, both
declined to comment. It didn’t take a conspiracy involving large numbers
of traders at different firms to move the rate. By nudging their
submissions up or down, traders at a single bank could influence where
Libor was fixed. Even inputting a rate too high to be included could
push up the final figure by sending a previously excluded entry back
into the pack.
“If you have a system like Libor, where highly
subjective quotes are built into the process, you have a lot of
opportunity for manipulation,” says Andrew Verstein, a lecturer at Yale
Law School in New Haven, Connecticut, and co-author of a paper on Libor
rigging published in the Winter 2013 issue of the Yale Journal on
Regulation. “You don’t need a cartel to make Libor manipulation work for
you.”
Rate setters at JPMorgan Chase & Co., Rabobank Groep,
Barclays, Deutsche Bank, RBS and UBS were given no training or
guidelines for making submissions, according to former employees who
asked not to be identified because investigations are continuing. At RBS
and Frankfurt-based Deutsche Bank, derivatives traders on occasion made
their firm’s submissions, they say. Spokesmen for all of the banks
declined to comment. Anshu Jain, co-CEO of Deutsche Bank and head of its
investment bank at the time, told investors at a panel discussion in
Germany on Jan. 21 that rigging Libor “sickens me the most of all the
scandals.”
As the credit crisis intensified in the fourth quarter
of 2007, Libor was a closely scrutinized gauge of the health of
financial firms. After years of relative stability, the benchmark became
more volatile. The average spread between the highest and lowest
submissions to the three-month dollar rate widened to about 8 basis
points in the three months ended on Oct. 30, 2007, from about 1 basis
point in the previous three months, data compiled by Bloomberg show.
The
volatility drew the attention of some bankers. On Aug. 28, 2007,
Fabiola Ravazzolo, an economist on the financial-stability team at the
New York Fed, received an e-mail from a member of Barclays’s
money-markets desk in London accusing the firm’s competitors of making
artificially low Libor submissions, according to transcripts published
by the regulator that didn’t identify the sender. Barclays that day had
submitted the highest rate to three-month dollar Libor, while the lowest
was posted by London-based Lloyds TSB Group Plc, suggesting Barclays
was having more difficulty obtaining funding than Lloyds, a bank later
bailed out by the U.K. government and now known as Lloyds Banking Group
Plc.
“Today’s U.S.-dollar Libors have come out, and they look too
low to me,” the e-mail from the Barclays employee said. “Draw your own
conclusions about why people are going for unrealistically low Libors.”
Lloyds,
in an e-mailed statement, declined to comment on what it called
“speculation by traders at other banks.” It wasn’t until the following
year, prompted by a March 2008 report by the Bank for International
Settlements and an April article in the Wall Street Journal suggesting
banks were low-balling their submissions, that the New York Fed and the
Bank of England asked the BBA to review the rate-setting process.
In
June 2008, New York Fed President Timothy F. Geithner sent a memo to
Bank of England Governor Mervyn King and his deputy, Paul Tucker,
putting forward a list of recommendations for improving Libor, including
increasing the number of banks that submit rates, basing the rate on an
average of randomly selected submissions and cutting maturities in
which little or no trading took place.
Aside from creating a
committee to review questionable submissions and promising to increase
the number of contributors to dollar Libor, the BBA didn’t implement
Geithner’s suggestions. Angela Knight, then the group’s CEO, said in a
December 2008 statement that Libor could be trusted as “a reliable
benchmark.”
Privately, regulators were skeptical. As the BBA was
drafting its proposals, King wrote to colleagues including Tucker on May
31, 2008, describing the group’s response as “wholly inadequate,”
according to documents released by the Bank of England in July. Rather
than press the BBA to change the way Libor was set, the Bank of England,
the FSA and the New York Fed demanded that any references to their
institutions be removed from the BBA review, the e-mails show.
A
spokesman for the Bank of England says Britain’s central bank “had no
supervisory responsibilities” for Libor at the time. The New York Fed
also “lacked direct authority over Libor” and didn’t want to be seen
endorsing a private association’s plan, according to Jack Gutt, a
spokesman. The New York Fed continued to press for reform through 2008,
he says.
Liam Parker, an FSA spokesman, referred to earlier
comments Adair Turner, chairman of that agency, made to British
lawmakers in July that the regulator was in contact with the CFTC in
Washington at a “very early stage” in an investigation the U.S. agency
began in 2008. The BBA said in an e-mail that it’s working with
regulators “to ensure the provision of a reliable benchmark which has
the confidence and support of all users.”
By failing to act,
regulators allowed rate rigging to continue over the next two years. At
RBS, the abuse was most pronounced from 2008 until late 2010, according
to people close to the bank’s internal probe. At Barclays, manipulation
continued until the second half of 2009. Japan’s Financial Services
Agency banned Citigroup Inc. from trading derivatives linked to Libor
and Tibor, the Tokyo interbank offered rate, for two weeks in January as
punishment for wrongdoing that started in December 2009.
Former
Barclays Chief Operating Officer Jerry Del Missier went further, saying
that the Bank of England encouraged the lender to suppress Libor
submissions. In October 2008, days before RBS and Lloyds sought
bailouts, the central bank asked Barclays to lower its quotes because
they were stoking concern about the bank’s stability, Del Missier told a
panel of British lawmakers on July 16. Tucker, the Bank of England
deputy director, told the panel he never gave such instructions.
“It’s
not adequate for the authorities to say, ‘We didn’t have
responsibility,’” says Paul Myners, a Labour Party member in
Parliament’s House of Lords and a U.K. Treasury minister from 2008 to
2010. “It was a huge oversight by the regulators not to realize that
Libor and other benchmarks were of such critical importance that they
should fall within the regulatory ambit.”
In the end, it was a
U.S. regulator without any banking oversight that took action. Vincent
McGonagle, a top enforcement official at the CFTC in Washington,
initiated a probe into Libor after reading the April 2008 Wall Street
Journal story. The agency sent letters to several banks that year
requesting information, according to a person with knowledge of the
investigation. The commission decided it had the authority to act
because Libor affects the price of futures contracts that trade on the
CME.
Banks opened their own investigations after the CFTC
inquiries. Barclays appointed Rich Ricci, then co-head of its investment
bank, to oversee an inquiry. As his team sifted through thousands of
pages of e-mails and transcripts of instant messages and phone
conversations, it uncovered evidence that traders were manipulating the
rate both up and down for profit, according to two people with knowledge
of the probe.
The CFTC came to the same conclusion in late 2009
or early 2010, according to the person with knowledge of the
commission’s inquiry. It happened when Gary Gensler, chairman for less
than a year, stood in the foyer of his ninth-floor Washington office as
Stephen Obie, acting head of enforcement at the time, played a Barclays
tape of a conversation between traders and rate setters, the person
said. “We had to vigorously pursue this,” Gensler says. “Sometimes
practice in a market gets confused and over the line, but nonetheless it
may still be illegal.”
The investigations revealed how widespread
the manipulation was. At UBS, traders made about 2,000 written requests
for movements in rates from late 2006 to late 2009. The majority were
sent by Hayes, the Tokyo-based trader who led a “massive effort” to rig
yen Libor, the CFTC said in a settlement with the bank in December.
Hayes also bribed brokers to disseminate his requests to other panel
banks and, on occasion, persuaded them to lie about where Libor should
fix that day, the Department of Justice said. Hayes, who traded
“enormous volumes” in yen swaps, made about $260 million in revenue for
UBS during the three years he worked there, the CFTC said.
At
Barclays, derivatives traders made 257 requests for U.S.-dollar Libor,
yen Libor and euro interbank offered rate, or Euribor, submissions from
January 2005 to June 2009, according to the settlement between the bank
and regulators. The requests for U.S.-dollar Libor were granted about 70
percent of the time.
Manipulating Libor was a common practice in
an unregulated market big enough to span the world though small enough
for most participants to know one another personally, investigators
found. Traders who worked 12-hour days without a lunch break were
entertained by brokers soliciting business, according to three people
familiar with the outings.
In March 2007, five months before the
onset of the credit crisis, a dozen traders from Lehman Brothers
Holdings Inc., Deutsche Bank, JPMorgan and other firms traveled to
Chamonix, according to people with knowledge of the outing. The group,
traders of yen-based derivatives, spent a day skiing before gathering
over mulled wine at a restaurant. They flew back late on Sunday, in time
for a 6 a.m. start the next day.
The trip was organized by
London-based ICAP Plc, the world’s biggest interdealer broker. Brokers
such as ICAP and RP Martin Holdings Ltd., also in London, were sounding
boards for those trying to set rates, especially after money markets
dried up, traders interviewed by Bloomberg say.
ICAP said in May
that it had received requests from government agencies probing banks’
Libor submissions and is cooperating fully. The firm said it had
suspended one employee and placed three others on paid leave pending the
outcome of the investigation. Two RP Martin brokers were arrested in
London on Dec. 11 as part of an inquiry into Libor rigging. Brigitte
Trafford, an ICAP spokeswoman, declined to comment, as did RP Martin
spokesman Jeremy Carey.
RBS in 2011 dismissed Tan, Danziger and
White, the rate setter, following the bank’s probe into yen Libor known
as Project Zen. Tan sued the bank for wrongful dismissal in Singapore in
2011, and the case is still before the court. Andy Hamilton, who traded
derivatives tied to the Swiss franc, also was fired for trying to
influence Libor. The bank has suspended at least three others, including
Jezri Mohideen, head of rates trading for Europe and the Asia-Pacific
region, according to a person with knowledge of the probe. White, Tan,
Danziger and Hamilton declined to comment. Mohideen said in a statement
issued by his lawyer that he never sought “to exert pressure on anyone
to submit inaccurate rates.”
Deutsche Bank has dismissed two
individuals, including Christian Bittar, head of money-markets
derivatives trading, three people familiar with the bank’s internal
investigation said. Barclays has disciplined 13 employees and dismissed
five, Ricci, now head of corporate and investment banking, told British
lawmakers on Nov. 28. At least 45 employees, including managers, knew of
the “pervasive” practices at UBS, the FSA said. More than 25 left the
Swiss bank following an internal probe, a person with knowledge of the
investigation said in November.
The Barclays settlement prompted
the U.K. government to order an inquiry into Libor. The report,
published in September, recommended stripping the BBA of its oversight
role, handing it to the Bank of England and introducing criminal
sanctions for traders seeking to rig the rate. “Governance of Libor has
completely failed,” FSA Managing Director Martin Wheatley, who led the
review, said when he released the report. “This problem has been
exacerbated by a lack of regulation and a comprehensive mechanism to
punish those who manipulate the system.”
The ubiquity of contracts
pegged to Libor leaves banks vulnerable to lawsuits. Barclays was
ordered by a British judge in November to release the names of
individuals involved in rigging rates after Guardian Care Homes Ltd., a
Wolverhampton, England–based owner of about 30 homes for the elderly,
sued for £38 million over interest-rate swaps that lost it money.
In
Alabama, mortgage holders have filed a class action in federal court
alleging that 12 banks colluded to push Libor higher on the dates when
repayments are set. The plaintiffs include Annie Bell Adams, a pensioner
whose home was repossessed, and Dennis Fobes, a 59-year-old salesman of
janitorial supplies whose house in Mobile is now worth less than his
mortgage. He says he refinanced in 2006 with a $360,000 adjustable-rate
mortgage linked to six-month dollar Libor. “It’s just another example of
how the banks have manipulated everything in their power,” Fobes says.
“I will fight them to the day I die to save my home.”
The city of
Baltimore and Charles Schwab Corp., the largest independent brokerage by
client assets, have filed suits claiming banks colluded to keep Libor
artificially low, depriving them of fair returns. At least 30 such cases
are pending in federal court in New York.
In London, lawyers at
Collyer Bristow LLP, a 252-year-old firm, are working on a plan that
would force banks to reimburse customers for any payments made under
contracts pegged to Libor. Stephen Rosen, who runs the firm, says
clients who entered into interest-rate swaps with banks may be entitled
to cancel those contracts because manipulation was so entrenched -- at a
cost of hundreds of billions of dollars.
“It’s possible on legal
grounds to set aside the swap contract entirely, which could mean you
can recover all the payments you’ve made under the swap,” says Rosen,
who wears thick-rimmed glasses and speaks in clipped, precise tones,
sitting in his office in a Georgian townhouse in the legal district of
Gray’s Inn. “The bank, when they entered into the swap, made an implied
representation that Libor would not be unfairly manipulated.”
Rosen
says his clients include a publicly traded real estate company, three
nursing homes and at least 12 more firms that bought Libor-linked
interest-rate swaps from banks. He declines to identify them by name,
citing confidentiality rules. “The client will argue, ‘Had you told me
the truth -- that you were fraudulently manipulating this rate -- I
would never have entered the contract with you,’” he says. “We are
calling this the nuclear option.”
To contact the reporters on this
story: Liam Vaughan in London at lvaughan6@bloomberg.net and Gavin
Finch in London at gfinch@bloomberg.net.
With assistance from
Silla Brush in Washington, Andrea Tan in Singapore and Francine Lacqua,
Lindsay Fortado and Jesse Westbrook in London.
To contract the editor responsible for this story: Robert Friedman at rfriedman5@bloomberg.net.
















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