Global regulators have exposed flaws in banks' internal controlsthat may have allowed traders to manipulate interest rates aroundthe world, two people with knowledge of the probe said.

Investigators also have received e-mail evidence of potentialcollusion between firms setting the London interbank offered rate,said the people, who declined to be identified because they weren'tauthorized to speak publicly. Regulators are focusing on a lack ofso-called Chinese walls between traders and employees makinginterest-rate submissions on behalf of their banks, the peoplesaid. In some cases, the two groups may have sat close to eachother, one person said.

Britain's Financial Services Authority is probing whether banks'proprietary-trading desks exploited information they had about thedirection of Libor to trade interest-rate derivatives, potentiallydefrauding their firms' counterparties, the people said. Theinvestigation may lead to civil fines for the banks and criminalcharges for the traders involved, the people said. No penalties arelikely from the FSA before year-end, and the case hasn't movedtoward criminal charges, one person said.

“The entire story is very embarrassing for the banks,” said TomKirchmaier, a fellow in the financial-markets group at the LondonSchool of Economics. “I don't know how they will eradicate this.The regulators have to rethink the way they set Libor.”

The rate, a benchmark for about $360 trillion of financialproducts worldwide, is derived from a survey of banks conducteddaily on behalf of the British Bankers' Association in London.

The lenders are asked how much it would cost them to borrow fromone another for 15 different periods, from overnight to one year,in currencies including dollars, euros, yen and Swiss francs. Aftera predetermined number of quotes are excluded, those remaining areaveraged and published for each currency by the BBA beforenoon.

Regulators worldwide are investigating whether banks attemptedto manipulate the London, Tokyo and euro interbank offered rates,known as Libor, Tibor and Euribor. The U.S. Securities and ExchangeCommission, U.S. Commodity Futures Trading Commission, U.S.Department of Justice, and Japan's Financial Supervisory Agency areall involved. The probes are being led separately, with individualregulators sharing some information among themselves, one of thepeople said.

JPMorgan Chase & Co., Deutsche Bank AG and HSBC Holdings Plcare among at least seven firms facing a Canadian probe into whetherthey participated in a conspiracy to manipulate prices oninterest-rate derivatives. The nation's Competition Bureau isinvestigating the firms' conduct between 2007 and 2010, accordingto documents it filed with the Ontario Superior Court in May.

Barclays, UBS

HSBC, Barclays Plc and Royal Bank of Scotland Group Plc areamong banks that have said they've received requests forinformation from global regulators in recent months. UBS AG said onFeb. 7 it had been given conditional immunity from the SwissCompetition Commission as part of an investigation intomanipulation of the Yen Libor, Tibor, and Swiss franc Libor rates.The Zurich-based lender was last year granted similar immunity bythe U.S. Department of Justice as part of its probes of Yen Liborand Euroyen Tibor rates.

Charles Schwab Corp., the largest independent brokerage byclient assets, sued Bank of America Corp., Citigroup Inc. and otherbanks in August claiming they manipulated Libor from 2007 inviolation of U.S. antitrust law.

Spokesmen for Schwab, HSBC, Barclays and Bank of Americadeclined to comment. An official at RBS couldn't immediatelycomment. Danielle Romero-Apsilos, a spokeswoman for Citigroup, saidin August the Schwab suit is “without merit.” She declined tocomment further yesterday.

Antitrust authorities are focusing on whether banks might havehelped a competitor manipulate one rate in exchange for help movingborrowing costs in a different currency, said another person withknowledge of the investigation. Regulators may view the conduct asa form of price-fixing because it could affect the price of thederivative products, the person said.

The FSA is investigating whether banks' Libor submissionsreflected their actual cost of borrowing and is scrutinizing marketdata for potential anomalies, another person familiar with theinvestigation said. The watchdog is scanning e-mails betweenbankers for code words that could be used to manipulate Libor, saidthe person, who declined to be identified because they weren'tauthorized to speak publicly.

Officials at the FSA in London declined to comment.

Competition Watchdog

Switzerland's competition watchdog said Feb. 3 it had opened aninvestigation into 12 banks, saying derivative traders might havecoordinated the submissions that determine Libor and Tibor. Tradersmight have colluded to manipulate the difference between the askprice and the bid price, or spread, of derivatives based on Liborand Tibor “to the detriment of their clients,” the regulatorsaid.

European Union antitrust regulators are also investigatingwhether banks formed a cartel to manipulate borrowing rates, saidtwo people with knowledge of the probe who declined to beidentified because the inquiry isn't public. Barclays, HSBC and RBShave said the European Commission quizzed them last year.

RBS, the U.K.'s largest government-owned lender, has dismissedat least four employees in connection with the probes, two peoplebriefed on the move said last week. New York-based Citigroup andFrankfurt-based Deutsche Bank also have dismissed, put on leave orsuspended traders as part of the investigations, according to twomore people.

Bloomberg News

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.