Chapter 12: Putting the Lies into Libor
With each new legal or technological development, financial market actors have sought to find trading information advantages over their rivals despite regulatory efforts to ensure universal access to market data. Particularly since ‘Big Bang’ in the City of London (1985–1986) financial institutions have developed increasingly sophisticated new financial instruments to permit the exploitation of narrow price margins in ever-tighter time-frames. In turn, the institutional opacity and technical complexity of these developments has made it more difficult to sustain journalistic scrutiny or regulatory oversight independently of insider sources.
The 2007–2008 sub-prime mortgage crisis and the ensuing ‘credit crunch’ have raised many questions about the identification and disclosure of financial risks and the capacity of financial analysts and reporters to assess them. Government bank bailouts and subsequent public austerity measures have also generated debate about the relationships that exist between financial markets, their regulators and financial media (e.g., see Schifferes and Roberts 2014; Starkman, 2014; Murdock and Gripsrud 2015).
The extent of the shortcomings of regulators and media in failing to identify the risks of sub-prime mortgage securities have been disputed. Nevertheless, the crisis certainly triggered several regulatory changes and a more critical tone in news reporting of banking. At face value, it might appear that such shifts ought to ensure that future systemic risks to the system are minimised.
However, that may be an over-simplistic reading of the changes that have taken place. Taking the Libor-rigging scandal as a focus, I argue that although some aspects of financial reporting and banking practices have doubtless changed for the better, other structural shortcomings remain largely unaddressed. Understanding the nature of these problems requires consideration of the evolving institutional priorities of the media, financial institutions and regulatory bodies. It also needs recognition that, in many respects, the verification of financial facts and events remains dependent on disclosures from financial regulators and government agencies.
The Libor Scandal
The London Interbank Offered Rate (Libor) is an international benchmark for currency lending and foreign exchange (forex or FX) trading originally developed in the 1980s by the British Bankers Association. The daily rates indicate the level of interest at which banks are able to source loans in different currencies over different periods. The estimated value of contracts and securities underpinned by Libor is somewhere between US$300 and $800 trillion (Wheatley Review 2012). The range of this official estimate reveals just how complex verifying the scale and value of financial securities has become. Libor rates directly influence the daily flows of US$5.3 trillion in forex-related trades, derivatives contracts (FX futures, swaps and options) and bank loans (including mortgages and related securities; BIS 2013).
Until 2014, Libor rates were calculated for ten major currencies across fifteen periods (from overnight to a year, with three-month figures the standard reference). A panel of up to eighteen major banks were asked, ‘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?’ The mean rate was then calculated and published by Thomson Reuters simultaneously across the entire market.
Not well understood outside financial markets, and overshadowed by the wider post-2007/2008 crisis, the revelations of Libor rate manipulation follow a rather uneven timeline (see BBC News 2013). Libor only became a full-blown scandal when it hit the headlines in 2012, following the release of bank communication records revealing collusive activities among the panellist banks. However, misgivings about the validity of the submitted Libor rates had begun to percolate through the financial sector as early as 2005 (see Brummer 2014; Davies 2015). In late 2007, regulators became aware of mass distribution emails expressing suspicions that Libor rates were being routinely under-estimated in case they engendered market perceptions of institutional vulnerability. Interestingly, Barclays (which would soon become the primary focus of the Libor scandal) intimated its own misgivings about Libor rigging to the BBA and the Commodity Futures Trading Commission, albeit without admitting its own complicity (Federal Reserve 2012; FSA 2012; Wheatley Review 2012). Meanwhile, a Barclays employee also privately communicated concerns to the Fed (Federal Reserve 2012; Milliken and Spicer 2012).
At this time, Libor did begin to receive some attention from the financial media, but the magnitude of the malfeasance underpinning the system was not yet apparent. For example, the ever-prescient Gillian Tett (2007) wrote a Financial Times piece noting BBA concerns about Libor mechanisms and rate discrepancies (see Amadeo 2014), and the Wall Street Journal carried similar reports (McDonald and MacDonald 2007; Gaffen 2007). In April 2008, the New York Fed Markets Group contacted the Barclays employee who had phoned the group previously. The call confirmed that the banks were worried that high Libor submissions could make an institution appear weak in an environment in which inter-bank credit was quickly evaporating (Federal Reserve 2012). The Fed’s subsequent weekly briefing note led to an increase in news reports asking questions about the possibility of Libor manipulation (Federal Reserve 2012).
As the credit crunch deepened in the aftermath of the Lehman brothers collapse in September 2008, valuation models and market liquidity broke down. Crucially, as the crisis deepened and banks stopped lending to each other, the transactions that might have provided an empirical referent for Libor submissions seized up (see Kregel 2012; Thompson 2013; 2015a). As Brummer (2014) notes, the credit crunch led to spreads between banks’ actual lending and borrowing rates widening to over one thousand base points, leading the BBA temporarily to suspend publication of the Libor rates (see also Economist 2008). Although not a direct result of the manipulation, Libor had effectively lost any coherent meaning and functionality as a common benchmark. As Mervyn King, the (then) Bank of England governor, quipped to a Treasury select committee, ‘Libor is the rate at which banks don’t lend to each other’ (quoted in Brummer 2014, 175).
The Trail of Electronic Evidence
As the rumours of rate manipulation spread, the financial media began to pick up the issue and raise more direct questions about the validity of Libor. However, the evidence of collusion stemmed not from investigative news reports but from regulator investigations requiring banks to divulge electronic communication records from financial chat rooms, trading room phone calls and messaging services (see Wheatley Review 2012; Vaughan and Finch 2012; Vögeli and Miller 2015; CFTC 2015b). Although the trail of evidence implicated a wide range of banks, it also pointed to two somewhat different motives behind the Libor manipulation (see Kregel 2012).
First, the reluctance of banks to issue credit to each other led to extreme caution in disclosing any information which might suggest liquidity problems, especially following the collapses of Northern Rock, Bear Stearns and Lehman Brothers (FSA 2012; Federal Reserve 2012). Submitting high rates relative to other banks invited speculation about solvency with potentially self-fulfilling consequences. Comments in exchanges involving Barclays traders reveal the intention was to avoid public speculation about the bank’s liquidity. For example: ‘Try to get our JPY [Japanese Yen] Libors a little more in line with the rest of the contributors, or else the rumours will start flying about Barclays needing money because its Libors are so high’ (quoted in FSA 2012, 25) and ‘going 4.98 for Libor only because of the reputational risk . . . basically the[re] is no money out there’ (also quoted in FSA 2012, 25).
Second, on a micro-institutional level, the ‘Chinese walls’ between trading desks and the bank officials responsible for submitting the Libor estimates were evidently porous. Although rate adjustments appeared small, they were significant for forex and interest rate traders, who depended on exploiting small margins or spreads through leverage. Taking the Wheatley Review’s lower estimate of Libor-dependent securities of US$300 trillion, even a single base-point shift up or down in the rate could potentially make a difference of US$30 billion to forex trading positions over a year (or US$82.2 million per day). Given that many traders’ bonuses are performance-based, the incentive for illicit collusion for personal and institutional gain becomes apparent.
Although senior management typically denied direct knowledge of the micro-level interactions between individual traders, it is implausible that they were unaware of the institutional pressure to avoid signs of vulnerability in the crisis aftermath. The electronic paper trail also suggests an awareness that practices violated regulations and subterfuge was expected. For example: ‘Careful how we speak with them about what we, how the rate is set’ (RBS trader, quoted in Vaughan and Finch 2012) and ‘don’t talk about it too much . . . the trick is you do not do this alone . . . this is between you and me but really don’t tell ANYBODY’ (Barclays trader to external counterparty, quoted in Slater and Ridley 2012).
Other electronic messages suggest Libor manipulation had become widely tolerated as routine practice within some institutions: ‘Could we pl[ease] have a low 6mth fix today old bean?’ (Deutsche Bank trader, quoted in FCA 2015, 3); ‘Look I appreciate the business and the calls we should try to share info where possible also let me know if you need fixes one way or the other’ (unidentified FX trader, quoted in CFTC 2015b, 6); ‘Dude, I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger’ (email to a Barclays banker, quoted in Slater and Ridley 2012).
The Legal and Regulatory Response to Libor Manipulation
The Libor investigations led to a series of formal proceedings and sanctions against the banks. It also became clear that effective manipulation of the rates required collusion across multiple institutions. Although Barclays was the first bank to come to the attention of financial regulators, eight banks have now been fined by UK and US regulators for a total of around US$9 billion. These include Deutsche Bank ($2.5 billion), UBS ($1.5 billion), Rabobank ($1.1 billion), RBS ($612 million), Barclays ($451 million), Lloyds ($383 million), ICAP ($88 million) and RP Martin ($2.3 million; Vögeli and Miller 2015). 2015 also saw the first UK jail sentence imposed on former UBS and Citigroup trader Tom Haynes.
Although these fines are doubtless substantial, they are only a fraction of the banks’ annual profits, and banks actively negotiated with regulators over the amounts to be paid to settle the matter (Vögeli and Miller 2015). Recently, US courts have also ruled out claims against banks for Libor manipulation (Van Voris 2015). Consequently, some critics have interpreted the settlements as unduly cosy and suggested links among the ‘revolving door’ relation between industry and regulators and the lack of court prosecutions and custodial sentences (e.g., Willett 2013).
It is important, however, to note that the BBA Libor system was based not on statutory law, but on a self-regulated market system. Proving that crimes were committed is therefore more complex than simply demonstrating that the Libor mechanism was being gamed. It is intrinsically difficult to calculate specific gains and losses in relation to any individual Libor submission or, indeed, to apportion blame to any specific person or institution. There are many other variables influencing FX-related asset values. A short-term nudge of a few base points on a specific currency on any particular day would benefit as many investors as it harmed. Similarly, while Libor manipulation technically affected hundreds of trillions of dollars’ worth of assets, the material impact on the general public should not be overstated. Libor was a public scandal, but the parties most affected were large financial institutions.
A further complication in the Libor scandal was the question of regulator and government complicity with the Libor manipulations at the height of the 2007–2008 crises. In the July 2012 Treasury Select Committee on Libor, Bob Diamond (the recently departed CEO of Barclays) revealed that a few weeks after the collapse of Lehman in September 2008, the deputy governor at the Bank of England (BoE), Paul Tucker, had called Diamond to signal that senior government officials had concerns about Barclays Libor submissions, which were consistently higher than other UK banks. According to Diamond: ‘Mr. Tucker stated the levels of calls he was receiving from Whitehall were senior and that, while he was certain that we did not need advice, that it did not always need to be the case that we appeared as high as we have recently’ (quoted in BBC News 2012b; see also BBC News 2012a, 2012c).
Diamond discussed the call with Jerry Del Missier, Barclays’ chief operating officer, who informed the select committee that he understood this to be an instruction to bring Barclays’ Libor rates down in line with other banks. Tucker, meanwhile, acknowledged that a cabinet secretary and Treasury official had discussed Libor rates with him, but strenuously denied that his conversation with Diamond could be construed as an instruction to rig Barclays’ submissions (BBC 2012c; see also Brummer 2014).
The evidence led to speculation that senior government officials regarded Barclays as potentially vulnerable and were willing to overlook discrepancies in Libor reporting with the goal of stabilising the sector. It certainly seems implausible that the BoE and government knew nothing of this until 2012. However, there is no evidence to support more conspiratorial claims that either knew about the level of collusion that preceded the crisis (Kregel 2012). The call to Diamond was perhaps better explained by Barclays’ continuing reluctance to accept government credit extended to stabilise the banks rather than any complicity with rigging Libor (Kregel 2012). Nevertheless, insofar as the BBA, FSA and BoE were aware of possible discrepancies with Libor from at least 2007, questions remain about why it took until 2012 for the full story to be uncovered. As Brummer observes, ‘No-one thought to look under the bonnet to see just what was going on’ (2014, 176).
The accumulation of communications records proving the extent of malfeasance led the Financial Services Authority to recommend an overhaul of the BBA-run Libor model (Wheatley Review 2012). The call made for a new system to be put out to tender, which was won by the Intercontinental Exchange (ICE) Benchmark Administration. ICE Libor now covers a smaller range of currencies, and although it still relies on responses from a panel of banks responding to the same question about borrowing rates, submissions must now reflect actual transactions, with legal prohibitions on making false claims. Moreover, the news model delays the publication of individual bank submissions to offset the risk of inviting speculation about liquidity. Thomson Reuters also ceased to be the collator and publisher of the Libor rates.
Mediation Issues and the Aftermath of Libor
Given that the evidence about Libor manipulation began to emerge in the midst of arguably the most serious systemic financial crisis since 1929, the delays in investigation and resolution are perhaps understandable. The banks responsible have been sanctioned, and the shift to ICE Libor was a significant reform. Indeed, the FSA has itself been restructured into the Prudential Regulation Authority and Financial Conduct Authority (overseen by the BoE’s Financial Policy Committee), which are intended to render financial activities more transparent and prevent recurrences of such collusion and manipulation.
The media coverage of the financial crisis and Libor scandal evidenced a willingness to be critical of the financial sector (banks in particular) and avoid financial elite capture (see Picard, Selva, and Bironzo 2014). The fact that Libor became a public scandal and that the reforms to the system have been pushed through is in large part attributable to the news media. However, the key revelations of inter-bank collusion still relied on disclosures from regulatory investigations. This suggests that financial media remained dependent on elite sources for information about internal market processes.
Such limitations do not stem primarily from a lack of journalistic endeavour. Financial events are not publicly accessible in the same way that, say, a public protest or a natural disaster would be. They are ontologically embedded in networks of shared meanings and information flows to which only market participants have direct access. Libor rates themselves are an epistemic construct derived from the metrics and methods of calculation. Ironically, their truth value depends not only on whether the panellist banks submit honest estimates but on whether the rates are collectively recognised as valid by the market as a whole. Although some journalists could discern problems with Libor from the anomalous spreads in the published data, the underlying causes of those anomalies were not apparent to them. The networks of information exchange that underpin professional financial market activity are not usually accessible to outsiders (see Thompson 2013; Davis 2015).
However, it would be premature to suppose that the Libor reforms (and those from the more recent FX fixing scandal), combined with a more critical media, will prevent a recurrence of such problems. The author’s recent interviews with both financial wire service editors/reporters and investment bank traders/executives in the City of London (in 2014) suggest a shift in the relations between news media and the banking sector. Now keen to minimise the risk of further reputational damage and regulator scrutiny, investment banks have introduced new restrictions on both internal and external communications. Internally, trading room protocols now routinely record all communications and regulate interactions with counterparties in other institutions. In some cases, personal cell phones and social media have been prohibited. These measures are understandable, but it remains unclear how this would affect the kind of informal communications that arise among traders in crisis scenarios when benchmarks like Libor break down and price activity cannot be discerned from brokerage screens (see Thompson 2015a, 2015b). Thus there are concerns that the new rules restrict entirely legitimate trading room communications. Some representative comments from interviews with senior investment bankers include the following: ‘In terms of observations and exchange of information, that’s one of the things that the regulatory regime now has, actually in terms of unintended consequences, nobody will share information with you any more’; ‘One of the customers made some comments about them checking pricing with other customers about what the other banks were offering. If the banks did that it would be called collusion or rigging the market. If I ring up [other banks named] and say “hey, how are you pricing [company name]?” and that’s recorded, that’s collusion’.
Meanwhile, in regard to bank interactions with the news media, there has been a significant reinforcement of gatekeeping protocols to manage who responds to journalistic enquiries. The referral of reporters to PR departments and communications managers is far from new, but the tighter rules make navigating these channels more complicated and serve to restrict access to traders at the coalface, as these comments from wire service reporters suggest: ‘Access to traders, decision-makers, deal-makers on the floor have become much, much more difficult, for a whole host of reasons. Obviously all the banks and institutions have tightened up massively on who they allow to speak to the press freely’; ‘There was a time, eight to ten years ago, where you would ring up the internal communications person and say can I talk to x y or z. Now they want to be in on the call and they will intervene if there’s a question asked that’s sensitive and they demand checking of quotes afterwards’.
There is no question that the Libor scandal revealed widespread unethical practices, although it is important to differentiate between cases in which reputational damage control was the motive and those driven by personal greed. Many bankers have become wary of what they regard as relentless and (in some cases) unfair media criticism, although one might argue that the banking sector has invited this upon itself.
The more complex question is whether the measures introduced to prevent recurrences of such malfeasance have adequately recognised the constructed nature of metrics such as Libor. The new communication restrictions will arguably make it more difficult for traders to validate price action in a crisis scenario when the shared confidence in benchmarks like Libor break down (especially given that ICE Libor is now based on the very transactional data that dried up at the height of the credit crunch). Meanwhile, journalists may find it more difficult to access the financial sources that have direct experience of the events being reported. As with so many responses to financial crises and scandals, the solutions may inadvertently carry the seeds of future problems.
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