Taha Habib – 22350

Regulations & Financial Markets – Assignment #1

A Brief on the LIBOR Scandal

During an international investigation in 2012, it was revealed that their existed a widespread
collusion between multiple banks to manipulate LIBOR in their interest. Amongst many, these
banks included Deutsche Bank, Barclays, UBS, Rabobank, and the Royal Bank of Scotland.

As some revelations suggest that LIBOR manipulation had started as early as 1991, during the
period, the banks named, used to alter the rates as per the conditions of the market. Barclay’s
first reported manipulation was during the economic upswing of 2005-07 to create an
atmosphere for its traders to profit from the derivatives market.

Following the economic boom of 2005-07, there came the financial crisis of 2007-08. In this
period, many banks were losing their credit worthiness due to excessive holdings of mortgage-
backed securities and the US housing crisis. Identifying the market situation, several banks
manipulated LIBOR downwards by telling LIBOR calculators that it could borrow funds at a
relatively cheap rate to create a perception of bank being less risky. Such manipulation during
such times provided these banks with a “degree of stability in an unstable time”.

What makes this scandal so significant is that in many financial markets, LIBOR was the sole
driver of pricing. The US derivative market was solely dependent upon these rates. Hence, such
manipulation was perceived as meddling with people’s trust and money. A person borrowing
fixed-rate mortgage when such rates were artificially bloated could perceive a part of mortgage
payments as theft.

How was the Scandal cracked?

The scandal was discovered when the banks were falsely manipulating their rates as to profit
from trades and the give the impression that they were more credit worthy than they were.

During 2007, Barclays alerted the U.S regulators that other banks were submitting falsely
manipulated low interbank rates. After this, the federal reserve observed LIBOR’s movement in
contrast to the market.

A year later in 2008, after Lehman brothers filed for bankruptcy, the LIBOR rates spiked up. The
movements in rates during that time became a center of attraction to regulators around the world.

In response to such movements, investigators in US, UK, and Canada launched their
investigations. Many employees of alleged banks were approached, out of which some became
the whistleblowers in exchange of immunity from prosecution. In an instance, a Barclays
employee told New York Fed Analyst that they are aware of the fact that they are not posting
honest LIBOR rates.

The scandal was unfolded primarily due to opposite movements in LIBOR as compared to the
conditions in the market. One instance of such movement was during the financial crisis of 2007-
08, the LIBOR rates were going downwards in an attempt to save some banks reputation of
being credit worthy.

LIBOR after 2021

As the aftermath of the LIBOR Scandal, the global financial system is now planning to depart
away from the use of LIBOR as a reference for the interbank offer rate. However, there still exist
a timeline for the bank to follow to effectively transition away.

Six Sterling and Yen LIBOR settings (1,3, and 6 months) will continue until the end of 2022 in
the form of “Synthetic LIBOR”. On the other hand, 5 USD LIBOR settings (Overnight and the
1,3,6 and 12 month) will continue to be calculated using the usual method until 30 th June 2023.

Apart from these, there have been some developments in the global financial market in the form
of alternatives of the LIBOR. These include Secured Overnight Funding Rate (SOFR), Federal
Funds Rate, Ameribor, Bloomberg Short-term Bank Yield (BSBY) index, €STR, and Sterling
Overnight Index Average (SONIA).

These are a combination of secured and unsecured form of lending that provides an alternative to
LIBOR. The common ground for these alternatives is that it is not based upon predictions are
observations but rather transactions that has already taken place in the market. For an instance,
SOFR is computed from transactions in the Treasury Repurchase market.
A Comparison between LIBOR & Secured Overnight Funding Rate (SOFR)

Term Rates
A key difference between LIBOR and SOFR is of the maturities at which they are quoted.
LIBOR could be estimated for seven borrowing periods ranging from one day to twelve months.
While on the other hand, SOFR only addresses overnight transactions.

Structure
Another Difference is that LIBOR is a forward-looking rate and SOFR is a backward-looking
rate calculated from transactions in the U.S treasuries repurchase market. hence during the
transition, there might be considerable adaptations.

Risk-free rate
Since SOFR is dependent upon the overnight treasury transactions, the rate quoted is considered
to be risk-free rate. On the hand, LIBOR is quoted by the quotation groups of banks, it involves
an element of credit risk.

Secured vs Unsecured
LIBOR borrowing is unsecured while SOFR borrowing is secured with U.S Treasuries.

Currency Options
SOFR is only denominated in USD while LIBOR is denominated in USD, GBP,EUR,JPY, CHF.