LIBOR

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The London Interbank Offered Rate (LIBOR) is the interest rate that banks charge each other to borrow short-term on the London interbank market. LIBOR is also the broader financial world's benchmark for setting short-term interest rates for products like variable-rate mortgages and corporate loans.

Since the time of its launch in 1986, the rate was compiled and published by the British Bankers Association (BBA). However, after a manipulation scandal that started as early as 2005 and implicated more than a dozen big banks, investor confidence in the accuracy of LIBOR plummeted, leading the UK regulatory panel to strip the BBA of its role in setting LIBOR.[1] In July 2013, it was announced that NYSE Euronext had won the contract to "administer and improve" the benchmark rate.[2] ICE acquired the NYSE Euronext Rate Administration, the name given to the division created to administer the benchmark rate, when it bought NYSE Euronext in 2013. ICE then re-named it the ICE Benchmark Administration.

Brief background

Its rate-setting mechanism involves using a reference panel of bankers, who each submit a rate based on perceived fair value pricing. BBA would then compile the list and publish the LIBOR rate at 11:00 am GMT daily. LIBOR loans are priced in Eurodollars - U.S. dollars in foreign hands - and can mature in as little as 24 hours. It is used as a reference rate for key financial products like interest rate swaps, short-term interest rate futures, credit default swaps and forex rates.[3]

Futures and options contracts on the LIBOR are a key component of the CME Group interest rate products suite, and are especially attractive to fixed interest money managers looking to hedge their short-term interest rate risk.[4] The CME lists 12 consecutive one-month LIBOR futures contracts that trade most actively near the quarterly expiration months of CME Eurodollar futures. More than 1.5 million LIBOR futures contracts trade daily on the CME.

LIBOR manipulation

In February 2012, more than a dozen traders and brokers in London and Asia lost their jobs, were suspended or were put on leave, as a result of a probe into the LIBOR system. The allegations included year of LIBOR price manipulation by major institutions, including Deutsche Bank, JPMorgan Chase, Royal Bank of Scotland and Citigroup. Inter-dealer broker Icap also suspended one employee and put two on administrative leave following the allegations.[5] U.S. and UK regulators requested information from Icap, as well as two other major inter-dealer brokers, Tullett Prebon and RP Martin, hoping to uncover data regarding information sharing among brokers, hedge funds and banks.[6]

The first fines related to the scandal were assessed in July 2012 to Barclays. The fines, which totaled about $450 million, were issued by the U.K. Financial Services Authority, the Commodity Futures Trading Commission and the U.S. Department of Justice. [7] UBS and the Royal Bank of Scotland (RBS) were also assessed fines in 2012 of $1.5 billion and $600 million, respectively. In January 2013, the International Organization of Securities Commissions (IOSCO) issued a consultation and request for comment on changes to the regulation of financial benchmarks such as LIBOR.[8]

On September 25, 2013, ICAP was fined a total of $87 million, including a $65 million settlement with the Commodity Futures Trading Commission (CFTC)and a $22 million settlement with Britain’s Financial Conduct Authority as part of an investigation into the LIBOR scandal. The U.S. Justice Department also brought criminal charges against three former ICAP employees over their roles in the manipulation scheme.[9]

On October 29, 2013, Dutch lender Rabobank admitted to criminal wrongdoing in regards to LIBOR manipulation and agreed to pay more than $1 billion in criminal and civil penalties to settle investigations by US, British and other authorities. Piet Moerland, the chairman of Rabobank’s executive board who functions as the chief executive, also resigned immediately in light of the findings in the investigation.[10]

In November 2013, UBS reached an immunity deal with European Union antitrust authorities to spare it from further fines in exchange for cooperating with investigators and turning over information about other banks involved in the rigging.[11]

The manipulation scandal dates back to before the financial crisis of 2008 when, leading up to this volatile period, numerous financial institutions were having difficulty obtaining short-term funding. Because LIBOR is set by member banks and involves individual submission of observed rates, rather than based on actual transactions, it was suggested that the daily rate fix is subject to manipulation. In the CFTC's charges against Barclays, the commission found that the bank "routinely made artificially low LIBOR submissions to protect Barclays’ reputation from negative market and media perceptions concerning Barclays’ financial condition."[12]

In 2008, U.S. bankers and investors complained that the LIBOR rate remained higher than it should have been, and charged that the way it is calculated is somehow flawed.[13] The rate spiked again in late April 2008 on news that the BBA was investigating whether banks had, in fact, been deliberately under-reporting the interbank rates they had been paying.[14]

Some observers pointed to the widening spread between LIBOR and the overnight indexed swap (OIS) rate - an indicator of expected central bank interest rates - as evidence that LIBOR is too high. Others said credit fears are not the problem, since banks' credit-default swap (CDS) premiums had been falling. As a result, the Bank of England in April 2008 introduced a Special Liquidity Scheme allowing banks to swap asset-backed securities for 9-month treasury bills to raise liquidity in the LIBOR market.

In October of 2014 it was reported that an unnamed senior banker from a UK bank became the first person to admit to conspiring to defraud by manipulating the LIBOR. The case arose from investigations by the UK's Serious Fraud Office.[15]

References

  1. Not So Fast, Libor Manipulation Still A Threat Under NYSE Euronext Takeover. Forbes.
  2. NYSE EuroNext to Take Over Administration of Libor. New York Times Dealbook.
  3. BBA LIBOR - Frequently asked questions. BBA.
  4. CME LIBOR Futures. CME Group.
  5. Libor investigation: traders fired and suspended - report. Telegraph.
  6. Brokers suspended in Libor inquiry. Financial Times.
  7. Libor scandal: Seven banks face US questioning. BBC.
  8. IOSCO Consults on Financial Benchmarks. IOSCO.
  9. U.S. and British Officials Fine ICAP in Libor Case. The New York Times.
  10. Rabobank to Pay More Than $1 Billion in Libor Settlement; Chief Resigns. The New York Times.
  11. UBS to Get Immunity in EU Libor Antitrust Case. The Wall Street Journal.
  12. CFTC Orders Barclays to pay $200 Million Penalty for Attempted Manipulation of and False Reporting concerning LIBOR and Euribor Benchmark Interest Rates. CFTC.
  13. Understanding LIBOR. A Dash of Insight.
  14. Bankers' trust. The Economist.
  15. Banker admits Libor fraud conspiracy. BBC News.