LIBOR & LIBORGATE

Recently there was a news that Barclays would pay $453 million to U.S. and British authorities to settle allegations that it had manipulated LIBOR , a benchmark interest rate that affects some $350 trillion worth of financial transactions. The scandal has since spread to implicate major banks and government regulators around the world, and could be one of the most expensive to hit the financial industry since the 2008 financial crisis. Now the questions which arises in our mind are What is LIBOR exactly?, How it is calculated?, How did Barclays manipulate LIBOR etc. LIBOR IN BRIEF LIBOR is an acronym for the London Interbank Offered Rate, a benchmark interest rate that is published daily. Libor is published under the auspices of the British Bankers Association (BBA),a trade association with over 200 member banks that addresses issues involving the United Kingdom banking and financial services industries. The BBA defines LIBOR as: The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11:00 [a.m.] London time. We can also define LIBOR as an indicative average interest rate at which a selection of banks (the panel banks) are prepared to lend one another unsecured funds on the London money market. Investors around the world use the LIBOR to calculate the interest rate on myriad forms of debt, from home mortgages and credit cards to municipal bonds and derivatives contracts. The Commodity Futures Trading Commission, which doggedly pursued the wrongdoing and brought the scandal to light, estimates that some $350 trillion worth of derivatives and $10 trillion worth of loans are based on LIBOR. LIBOR CALCULATION The LIBOR interest rates are not based on actual transactions. On every working day at around 11 a.m. (London time) the panel banks inform Thomson Reuters for each maturity at what interest rate they would expect to be able to raise a substantial loan in the interbank money market at that moment. The reason that the measurement is not based on actual transactions is because not every bank borrows substantial amounts for each maturity every day. Once Thomson Reuters has collected the rates from all panel banks, the highest and lowest 25% of value are eliminated. An average is calculated of the 50% remaining mid values in order to produce the official LIBOR rate. Suppose there are 16 banks in the panel which submitted their estimated rate for each maturity to Thomson Reuters. Now out of this lowest four rates (lowest 25%) and highest four rates(highest 25%) would be eliminated. Average of remaining eight rates is calculated and published as the LIBOR for the day.

LIBOR CURRENCIES At present LIBOR interest rates for ten currencies are calculated. This currencies are -: American dollar - USD LIBOR Australian dollar - AUD LIBOR British Pound Sterling - GBP LIBOR Canadian dollar - CAD LIBOR Danish krone - DKK LIBOR European euro - EUR LIBOR Japanese yen - JPY LIBOR New Zealand - NZD LIBOR Swedish krona - SEK LIBOR Swiss franc - CHF LIBOR

LIBOR MATURITIES LIBOR rates are calculated for 15 different maturities. These are :One day One week Two weeks One month Two months Three months Four months Five months Six months Seven months Eight months Nine months Ten months Eleven months Twelve months

LIBOR MANUPULATIONS BY BARCLAYS LIBOR works on a kind of honor code, so the manipulation part is fairly simple: Barclays reported a lower interest rate than it actually was paying. Barclays' alleged motive was to secure cheaper loans and to make itself appear healthier during the financial turmoil than it actually was.

The basis for a Contributor Panel banks submission, according to the BBA, must be the rate at which members of the banks staff primarily responsible for management of a banks cash, rather than a 2banks derivative trading book, consider that the bank can borrow unsecured inter banks funds in the London money market. Further according to the BBA, a Contributor Panel bank may not contribute a rate based on the pricing of any derivative financial instrument. In other words, a Contributor Panel banks LIBOR submissions should not be influenced by its motive to maximize profit or minimize losses in derivative transactions tied to LIBOR. Barclays did the exact opposite. Within Barclays LIBOR rate where manipulated through two different ways :Swaps Traders Requests Within Barclays Interbank Swaps Trader Requests

Swaps Traders Requests Within Barclays From approximately 2005 through 2007, and occasionally thereafter through approximately 2009, certain Barclays swaps traders requested that certain Barclays LIBOR submitters submit LIBOR contributions that would benefit the traders trading positions, rather than rates that complied with the definitions of LIBOR. Those swaps traders either proposed a particular LIBOR or contribution for a particular tenor and currency, or proposed that the rate submitter contribute a rate higher, lower, or unchanged for a particular tenor and currency. The swaps traders made these requests via electronic messages, telephone conversations, and in-person conversations. The LIBOR submitters agreed to oblige, and obliged, the swaps traders requests for favorable LIBOR submissions on numerous occasions. In the instances when the published rates were manipulated in Barclayss favor due to Barclayss manipulation of its submissions, that manipulation benefitted Barclays swaps traders, or minimized their losses. Certain Barclays swaps traders and rate submitters who engaged in efforts to manipulate LIBOR submissions were well aware of the basic features of the derivatives products tied to these benchmark interest rates; accordingly, they understood that to the extent they increased their profits or decreased their losses in certain transactions from their efforts to manipulate rates, their counterparties would suffer corresponding adverse financial consequences with respect to those particular transactions.

Interbank Swaps Trader Requests From at least approximately August 2005 through at least approximately May 2008, Certain Barclays swaps traders made requests of traders at other Contributor Panel banks for favorable LIBOR submissions from those banks. In addition, certain Barclays swaps traders received requests from traders at other banks for favorable LIBOR submissions from Barclays rate submitters. When Barclays swaps traders did not have trading positions conflicting with their

counterparts requests, those Barclays swaps traders sometimes would agree to request a LIBOR submission from the Barclays LIBOR submitters that would benefit their counterparts positions. Those interbank communications included ones in which certain Barclays swaps traders communicated with former Barclays swaps traders who had left Barclays and joined other financial institutions. The likelihood that the LIBOR fix would be affected increased when other Contributor Panel banks also manipulated their submissions as part of a coordinated effort.

POSSIBLE VICTIMS OF THE SCANDAL : The time period when this whole scandal took place can be divided in to two phases : Phase 1 Phase2 Phase1 (2005 -2007) Before the financial crisis , there is serious evidence that swap traders regularly requested for higher LIBOR rates so as to make extra bucks. It wasn't one conspiracy, but many different people trying to influence specific bets they made on LIBOR. These were likely small changes, but with billion dollar bets hanging in the balance around the world, it could mean a lot. According to rough estimate LIBOR affects close to $350 trillion of financial transactions throughout the world. So even 1% of change can means $3.5 trillion of illegal movements. If Barclays traders managed to get the rates higher before the financial crisis, as they requested, then consumers suffered. All the consumers who had loans i.e. right from educations loans to home loans that was based on LIBOR might have a slightly higher rate. Its hard to tell at this point just how much rates changed, but it's a possibility.

Phase2 (2007-2009) During this period when the whole world was engulfed with financial crisis , Barclays through the manipulation of LIBOR reported low borrowing interest rates. This was used to given signal to the investors that bank is doing good in tough times. When the rate was going down during the crisis, consumers might have gotten better deals on their loans. But that doesn't mean we should celebrate. A lot of cities and pension funds and transportation systems had money in LIBOR based investments. They would have made a lot less money if LIBOR was manipulated down. The City of Baltimore, for instance, is suing and claims to have lost millions of dollars in the manipulation. One thing that took hit for sure due to the revelation of this scathing manipulation is the reputation of financial institutes. And it will take huge effort on the part financial institutions to gain same level of trust as before the scandal.

INVESTIGATION AND ITS PROGRESS

The first major milestone as far as investigation is concerned was when The U.S. Commodity Futures Trading Commission (CFTC) Ordered Barclays to pay $200 Million Penalty for Attempted Manipulation of and False Reporting concerning LIBOR benchmark interest rates. According to the Order, Barclays, through its traders and employees responsible for determining the Banks LIBOR submissions (submitters), attempted to manipulate and made false reports concerning both benchmark interest rates to benefit the Banks derivatives trading positions by either increasing its profits or minimizing its losses. The Order also finds that throughout the global financial crisis in late August 2007 through early 2009, as a result of instructions from Barclays senior management, the Bank routinely made artificially low LIBOR submissions to protect Barclays reputation from negative market and media perceptions concerning Barclays financial condition. In addition to this Barclays paid $160 million to the U.S Justice Department and close to $93 to British Authorities. Barclays chief executive Bob Diamond and chief operating officer Jerry del Missier resigned after the coming of CFTC orders. The U.S. Justice Department is reportedly considering bringing criminal charges against several U.S. banks. Citigroup is also a target of investigation. Earlier this year, it emerged that a few traders at Citigroup and UBS tried to manipulate Libor rates for the Yen . The Times of London reported that Royal Bank of Scotland could soon be hit with a fine of up to $150 million for related charges.

The framing of charges and court orders against Barclays is only the tip of iceberg. Many more revelations to come in future as the investigation progresses.

REFERENCES http://theweek.com http://www.npr.org http://www.corporatecrimereporter.com http://www.nytimes.com http://www.global-rates.com

Rahul Kaushik PGDIM 19 NITIE 9769758507

Author did his engineering from School Of Engineering, CUSAT, Kochi, Kerala. He worked for TCS for close to two years. Currently he is first year student in PGDIM program in NITIE.