Do the allegations of Libor-related fraud in the first UK proceedings and the class action brought in the US by homeowners in the wake of the Libor rate-fixing scandal represent the tip of the iceberg?
A class action filed by US homeowners in New York against 12 banks, including Barclays, alleges that Libor rate-fixing by the banks caused their mortgage repayments to increase, costing them thousands of dollars each. In the UK, a claim by Graiseley Properties and others against Barclays for alleged mis-selling of interest rate swaps has been amended to include allegations of fraud in relation to misrepresentations concerning Libor rates (Graiseley Properties Ltd v Barclays Bank Plc). Could these be the first of a series of claims? If so, what are the implications for financial institutions and their insurers?
Who will claim?
These first two actions demonstrate the breadth of claims which could arise from Libor fixing and the variety of possible claimants, ranging from individuals who have mortgages to wealthy investors and companies who took out loans or entered into derivatives contracts. Derivatives, for the uninitiated, are financial instruments such as futures, forwards, options and swaps. Since Libor is used as a benchmark rate in derivatives markets, an attempt to manipulate Libor amounts to an attempt to manipulate those markets. Calculations linked to Libor are estimated to underpin €350 trillion in derivatives world-wide, so there is obvious potential for a very substantial number of claims.
It is clear, as was observed by Flaux J in the Graiseley Properties case, that there was fixing not only of sterling and dollar Libor, but also of EURIBOR, the rate at which Eurozone banks offer to lend unsecured funds to other banks in the euro market. This will expose EU banks and their insurers to collective actions brought by homeowners and companies in other jurisdictions.
What will they claim?
The US action focuses on increases in the Libor rate submissions by banks which it is said allowed the banks to raise the interest rates paid by homeowners on Libor-linked loans. It is reported that an analysis of Libor rates over several years up to 2009 shows it was higher on the first day of each month which was when the repayment rate for such loans was set. It is alleged that this meant repayments were artificially high. This all sounds relatively simple. However, the information disclosed by the regulators’ investigation into Barclays` derivative traders indicates the contrary, suggesting that the traders wanted to keep Libor low. Their motive for understating Libor was to maximise their profit (or decrease losses) resulting from certain derivative transactions tied to Libor.
What is certain about the UK action, judging by Flaux J`s comments in Graiseley Properties, is that the courts will accept that the traders were well aware of the features of the derivative products tied to these benchmark rates. They understood that, insofar as their manipulation of the rates in transactions served to increase their profits, or decrease their losses, their counterparties would suffer corresponding adverse financial consequences.
Claims could also be brought by those who received interest linked to Libor such as pension fund beneficiaries and other investors. Where Libor submissions were artificially lowered, they may be able to show that they received less interest on their investments than they should have, but for the “rigging”.
It is fair to say that it will not be straightforward for the claimants to prove their losses and establish that the banks’ or traders` false Libor submissions affected the overall Libor rate.
Is there a defence?
In circumstances where, in the case of Barclays at least, they have accepted responsibility for employees involved in fixing the rate, and where some of the banks seem to have known about the practice since 2005, it is difficult to see what credible defences can be raised. It will be interesting to see the basis upon which claims are brought, but we would expect defences to focus on issues relating to causation and loss, rather than in defending the allegations of rigging. We would also expect banks to want to try to settle some of these claims at an early stage, rather than risk the adverse publicity of proceeding to trial.
What about insurers?
For those banks that have not already done so, news of the latest actions may trigger notifications of circumstances to their insurers. Until there is more clarity as to the types of claims being made, it is difficult to predict whether those claims will be covered. But, given the acceptance by some of the banks involved of dishonest or fraudulent conduct on the part of employees involved in “rigging” - following investigation by UK and US regulators - such activity may not fall within typical E&O wordings. If the practice of Libor rigging has been going on for several years, insurers might also be entitled to decline on the basis that banks were aware of the problem prior to inception and/or failed to disclose the practice. Too late now, surely, to notify their current insurers.
Banks may attempt to notify under fidelity and D&O wordings but other arguments may then be open to insurers, not least since the evidence to date suggests that dishonest traders intended to benefit both themselves and the banks for which they worked (typical fidelity covers require harm/financial loss to be caused to the insured itself). And if banks have benefited from the practice themselves, the question might arise whether resulting claims fall within the scope of typical insuring clauses, or amount rather to unjust enrichment on the part of banks, obliging them to reimburse monies to some claimants.
Notifications by banks and claims which subsequently arise will, however, require detailed consideration of individual policy wordings.
At this stage there are more questions than answers but significant coverage of these issues is expected and we will closely follow developments.