DR.CHENJIAZI ZHONG

Essentials of LIBOR

The London Interbank Offered Rate (LIBOR), is the average interest rate at which banks make short-term loans to one another. It is a borrowing rate set daily by a panel of banks, which currently comprises 18 banks. The rate is calculated for ten currencies and for 15 maturities from overnight to one year, and are published daily after 11am (London time) by Thomson Reuters. LIBOR is used as a benchmark to set payments on about $800 trillion-worth of financial instruments, ranging from simple mortgages to interest-rate derivatives, including Eurodollar contracts and interest rate swaps.

Theoretically speaking, LIBOR is an objective and honest number, as 1) it is assumed that banks play by the rules and give truthful estimates; 2) the market is sufficiently small that most banks are presumed to know what the others are doing.

The scandal this time seems to focus on Barclays PLC. In settlements with the Financial Services Authority (FSA) in Britain and America’s Department of Justice, Barclays accepted that its traders had manipulated rates on many occasions. The Firm was fined $453 million by U.S. Commodity Futures and Trading Commission (CFTC) and FSA for manipulating data, which went into calculations of LIBOR last month.

Investigations by regulators from Canada, America, Japan, the EU, Switzerland, and Britain, are looking into allegations that LIBOR and similar rates were rigged by a large numbers of banks. The institutions that are either co-operating with the regulators or being questioned include Citigroup, Deutsche Bank, HSBC, JPMorgan Chase, RBS, and UBS.

Impacts and Implications of LIBOR Manipulation

• Since LIBOR is used in the pricing process for a number of financial instruments, in particular OTC derivatives, interest rate swaps, collars and caps with varying levels of complexity, the so-called “interest-rate-protected/enhanced structured products” would have given inaccurate explanation and untruthful representation to investors. These derivatives are based on LIBOR as the reference rate, in another word, there would have been no base rate hedging the market.
• For homeowners, car and student loan payers, e.g., if LIBOR was being manipulated upwards, payments would have been pushed up; if the rate was being manipulated downwards, this would have ended up less payments, in which case that the investors would have suffered.
• For banking industry, reputation and long-term image have been damaged. It is now taken as a “tobacco moment” – trust and truth.

Timeline of LIBOR Scandal:

• 2005: Evidence was disclosed that Barclays had tried to manipulate dollar LIBOR and Euribor rates at the request of its derivatives traders and other banks. According to FSA, Barclays derivatives traders made a total of 257 requests to fix LIBOR between January 2005 and June 2009.
• 09/2007: Barclays manipulated LIBOR submissions to give a healthier picture of the bank’s credit quality and its ability to raise funds.
• 03/2008: the Bank for International Settlements has stated that “available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings.”
• 5/29/2008: Banks understated borrowing costs they reported for LIBOR during the 2008 credit crunch: rates at Citigroup, e.g. could borrow dollars for three months were about 87 bps lower than the rate calculated using default-insurance data.
• 2008: Timothy F. Geithner, the U.S. Treasury Secretary, who was president of the Federal Reserve Bank of New York at that time, sent Bank of England recommendations for improving calculations of LIBOR.
• 3/2011: Regulators focused on Bank of America Corp, Citigroup Inc., UBS AG, and subpoenas were issued; governors at Bank of England disclosed that “it is not the rate at which anyone is actually borrowing.”
• 02/28/2012: U.S. Department of Justice conducted a criminal investigation into LIBOR abuse, regarding the possibility that traders were in direct communication with bankers before the rates were set, thus allowing them an advantage in predicting that day’s fixing.
• 06/27/2012: Barclays Bank was fined $200 million by the Commodity Futures Trading Commission, $160 million by the United States Department of Justice and £59.5 million by the Financial Services Authority for attempted manipulation of the LIBOR and EURIBOR rates. On July 2^nd, 2012, Marcus Agius, Chairman of Barclays, resigned from the position following the interest rate rigging scandal. Bob diamond, Chief Executive Officer, resigned on the following day.
• 07/06/2012: U.K. Serious Fraud Office opened a criminal investigation into the attempted manipulation of LIBOR.