Barclays has been slapped with a record Financial Services Authority (FSA) fine of £59.5m for its role in manipulating Libor. The FSA action is in conjunction with US regulators who have fined Barclays a further US$360m. Barclays is probably just the first in a host of up to 40 banks to be named and shamed in this sorry tale.
In this article, we explain what Libor is and how it is calculated. We then consider the Libor claims that have been circulating in the financial media for some time but which have now achieved headline status following Barclays’ very public censure.
What is Libor?
Libor is an acronym for London interbank offered rate, a rate representing the average that banks are paying to each other to borrow money in the short term. Libor is calculated daily for 10 currencies over 15 different maturity periods, ranging from overnight to a year.
A panel of contributor banks make daily submissions to the British Banking Association by way of response to the following question: “At what rate could you borrow funds if you were to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11am?”
The figures provided may not be based on actual transactions carried out by that bank if it has not executed any such transactions in the 10 currencies over the 15 maturity periods. Where it has not done so, the banks are expected to use their knowledge of their own risk profile and actual transactions to construct a curve to predict accurately the correct rate for those currencies or maturities in which it has not been active. The stipulated basis on which each bank’s Libor submissions are to be made does not allow for a bank’s self-interested considerations to be taken into account.
Libor is the primary benchmark for short-term interest rates globally and, as such, is incorporated into standard derivative and loan documentation. It is increasingly used as a barometer for retail loan products such as mortgages and corporate loans, and any personal short-term borrowings. The FSA in its Barclays’ enforcement notice notes that US$ 554trn of OTC interest rate derivative contracts were linked to Libor in 2011. Just a small amount of mispricing could lead to billions of dollars of claims.
What have the banks done?
Put simply, the banks are said to have lied about the true rate at which they can borrow. Instead, they manipulated the results for a variety of reasons. The findings of the FSA about Barclay’s wrongdoing simply confirmed speculation that has been ripe in the markets for some months/years. The principal motivations are said to have been the following:
- In the period following the seizing-up of the financial markets in 2007, Barclays and other banks reported lower borrowing rates than the rate at which banks were, in reality able to borrow. This was done to give the impression that the banks were healthier than they in fact were.
- In the period prior to the financial collapse (and perhaps ongoing), banks are said to have reported borrowing rates at levels in order to benefit their derivative traders who gained profits as a result.
- It is also said that traders were in direct communication with bankers before Libor was set on any particular day, thereby giving those traders insider information into the global instruments that are underpinned by Libor.
What is the fallout?
Regulatory investigations and actions
The Barclays investigation was a co-ordinated action by the UK’s FSA, working in conjunction with the US Commodities Futures Trading Commission (CFTC) and the US Department of Justice (DoJ). In addition, Libor setting has received the attention of most of the world’s financial regulators, in particular the US Securities and Exchanges Commission (SEC), the Japanese Securities and Exchange Surveillance Commission, the Canadian Competition Bureau, the Swiss Competition Commission and the European Commission.
Barclays’ fines are breathtaking. The FSA’s fine was originally £85m but reduced to £59.5m, reflecting Barclays’ co-operation with the investigation. Even the reduced amount is the FSA’s largest ever fine. In addition, the CFTC has fined Barclays US$200m and the US DoJ has levied a further fine of US$160m.
It is not just Barclays. The Barclays enforcement notice refers to collusion between Barclays and other banks but has not yet named other participants. Documents filed in an action brought by the Canadian Competition Bureau into alleged collusion into the setting of yen interbank lending rates has referenced traders at Citigroup, Deutsche Bank, HSBC, JP Morgan Chase, RBS and UBS. News reports are that as many as 40 to 50 financial institutions may have been party to such rate-setting manipulation.
In the US, it is reported that UBS has turned whistleblower in order to take advantage of immunity offered by US regulators to the first company to report its involvement in illegal cartel conduct. Alongside the regulatory investigations, the SEC is conducting a criminal inquiry into Libor abuse. Among the things being investigated is the possibility that traders were in direct communication with bankers before the rates were set.
Civil suits by disgruntled investors have also being filed. Investors who have lost out appear to be those who bought Libor-linked derivatives, and for whom, therefore, suppression of Libor reduced returns on their investments.
Charles Schwab Corp has filed suit against 11 banks – including Barclays, Bank of America, Citigroup, HSBC, JP Morgan and Credit Suisse – in US civil cases brought on behalf of investors of differing sizes who say they have lost profits resulting from Libor distortion as far back as 2006. FTC Capital has brought a similar action. The City of Baltimore is also a plaintiff. Like many US cities, Baltimore entered into interest rate swaps to protect them from movement in floating rate borrowing. It is said that the manipulation of Libor could have led to Baltimore losing millions of dollars each year. If all impacted US cities brought similar actions, it has been estimated that combined damages could be as high as US$40bn. The findings against the FSA are likely both to bolster the claims already made and also encourage other suits to follow.
Two shareholder derivative actions have been instigated in the US (one by a Bank of America shareholder, the other by a Citigroup shareholder) against former and current directors and officers claiming breaches of fiduciary duty – in particular, regarding lack of oversight relating to the banks’ purported manipulation and suppression of Libor from as early as 2006.
In the UK, the first Libor-related claim has now been filed in the English High Court against Barclays Bank. It is alleged that Barclays missold complex derivative products and then applied an artificially low Libor rate. It is said by the claimant, a care home business, that a January 2009 decision by Barclays that the company was in breach of a loan-to-value covenant could have been incorrect if the Libor rate, off which the business’ hedging products were valued, was being suppressed. The exit costs on the hedges taken out by the company increased as interest rates fell and were added to the business’ total borrowings. Accordingly, a lower Libor rate resulted in higher break costs. The claimants are seeking £36m in damages.
Wrongful dismissal claim
In Singapore, RBS has been defending its firing of a former trader for gross misconduct for allegedly influencing RBS’s Libor rate setters from 2007-2011 in order to boost the traders’ profits. The former employee is seeking substantial damages for wrongful dismissal. In his action, he claims that it was, in fact, common practice among senior RBS employees to make requests to their Libor-rate setting team as to the appropriate rate.
There is a clear potential for E&O, D&O and EPL policies to be affected by the Libor allegations. Initial exposure seems most likely from regulatory costs claims under both D&O and civil liability covers. Civil liability claims have already been made and no doubt more will follow hot on the heels of the FSA’s recent actions. Given the number of regulators from different jurisdictions that are investigating the allegations, the costs involved in the banks defending their actions to the regulators will probably be significant. With Libor claims likely to gather momentum, the civil liability exposure (if covered) could, in the long run, be much greater.
Depending on the facts of the case, various policy exclusions may come into play. In particular, insurers should assess the impact of antitrust, deliberate corporate acts, market abuse, and dishonesty and fraud exclusions. Any insurers receiving notifications now rather than months/years ago, should also query the timing of such notifications.
And for the next scandal?
The pain for the banks just keeps on coming. At the end of June, the FSA announced that it had unearthed serious failings in the sale of interest rate hedging products to various small and medium-sized businesses. In the FSA’s view, this has had a severe impact on many of these businesses. The Authority has now reached an agreement with Barclays, HSBC, Lloyds and RBS to provide appropriate redress where misselling has taken place.
Ironically, this particular spate of misselling is based on representations said to have been made by banks that interest rates would keep on rising – representations made at a time when we now know they were being artificially suppressed. Barclays is again in the firing line along with RBS and HSBC.