In addition to the various regulatory fines imposed upon several UK Banks since 2012, there have been three further criminal convictions for LIBOR rigging made against former Barclays traders this week. berg asks – has LIBOR always been a rigged rate?

LIBOR background

LIBOR is the rate that Banks and Building Societies lend to each other. When LIBOR was set up in the 1980s, it was measured using 24 hours, 3 months, 6 months, 9 months and 12 month benchmarks. Each submitting Bank provided a rate by 11am each day, and an average weighting was published at 11:30am. The weighting detailed the cost of borrowing in sterling, US dollars, Swiss francs and Japanese yen. Since its inception, LIBOR has been linked to derivatives contracts.

However, until 2012, many people were not aware that LIBOR wasn’t based on actual transactions but was based essentially on guesswork and/or estimation. Each day, each Bank submitter is asked by ICE (formally the BBA): “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am London time?”

When the liquidity crisis and credit crunch hit after the collapse of Lehman Brothers, the problem was that Banks were not borrowing or lending to each other, and therefore the daily submission was essentially a guess. But submissions still had to be made because

“By 2012, the commercial value of all the money riding on LIBOR was $350 tn (£265 tn). That are 5 times as much as everything produced in the year in the entire world. Yet the market on which it was based – the market for Banks borrowing cash from each other – was more like $10 tn. A case, perhaps, of putting the cart before the horse”. (Andrew Verity, BBC Article)

Litigation and convictions

In 2015, Tom Hayes became the first individual to be convicted for LIBOR rigging and is currently serving an 11 year sentence in prison.

In America, more than $2billion has been paid out in settlements and litigation with the Banks colluding in circumventing the BBA rules.

“They allege that the banks, as sellers, colluded to depress LIBOR, and thereby increased the cost to appellants, as buyers, of various LIBOR-based financial instruments, a cost increase reflected in reduced rates of return. In short, appellants allege a horizontal price-fixing conspiracy, ‘perhaps the paradigm of an unreasonable restraint of trade.’” (http://blogs.reuters.com/alison-frankel/files/2016/05/052316-2nd-Cir-Libor-decision.pdf)

In Singapore, documents filed in litigation against RBS alleged the London LIBOR market was a cartel. Evidence put before the court included instant messaging conversations agreeing to rig the rate.

In January 2016, five further traders were cleared of assisting Hayes in his manipulation of the rate. However, yesterday, three former Barclays employees were all found guilty of rigging the interest rates between 2005 and 2007 at Southwark Crown Court. They are yet to be sentenced. Prosecution was brought by the Serious Fraud Office (“SFO”).

Summary

It is clear from the above that the traders were motivated and incentivised to rig rates in the Banks’ favour. Furthermore, because even tiny movements in the daily rate could mean gains or losses of millions of pounds, Banks were colluding together to set rates which suited their interests, despite not always lending money to each other.

Is LIBOR therefore by its very nature a flawed rate, one which relies on estimation rather than actual transactions and thereby lending itself to abuse? berg raises the question whether the market practices in place were so endemic that it was essentially doomed from the start.