Libor Fixes May Not Be Enough

Investors say new CFTC rules aren’t enough to salvage discredited benchmark.

The blueprint regulators gave Barclays Plc and other banks for correcting Libor-rate abuses may not be enough to salvage a benchmark so discredited it needs to be overhauled.

The U.S. Commodity Futures Trading Commission ordered Barclays on June 27 to keep thorough records on how it comes up with its London interbank offered rate submissions and erect so-called Chinese walls between traders and rate-setters. It also said lenders should expect random checks from regulators on whether their submissions reflect actual borrowing costs. Investors say the plans are little more than window-dressing.

“As long as banks are allowed in the henhouse, then the system is ripe for abuse,” said Tim Price, who helps oversee more than $1.5 billion at PFP Group LLP, an asset-management firm based in London. A better system would be to take random samplings from all the transactions, he said. “If there is any message of the last few years, it’s that banks and bankers simply cannot be trusted.”

Barclays, the U.K.’s second-largest lender, was fined a record $451 million and its top executives agreed to forgo bonuses after investigators found traders and senior managers “systematically” tried to rig the Libor and Euribor, its equivalent in euros. With other lenders facing similar sanctions, the British Bankers Association, which oversees Libor, is under pressure to prove the rate serves a purpose.

Libor is determined by banks’ daily estimates of how much it would cost them to borrow from one another for different time frames and in different currencies. Because banks’ submissions aren’t based on real trades, the potential exists for manipulation by traders. At least a dozen firms are being probed by regulators worldwide for colluding to rig the rate, the benchmark for $500 trillion of securities, including mortgages, student loans and swaps.

Barclays employees overseeing Libor and Euribor submissions routinely accommodated requests that benefited traders at their own and other banks, the CFTC said.

On Sept 13, 2006, a senior Barclays trader in New York e-mailed the person who submitted the rate, “Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the lib or fixing at 5.39 for the next few days. It would really help,” according to a CFTC document.

In another exchange, from April 7, 2006, a submitter responded to a request for low U.S. dollar Libor submissions from a swaps trader with “Done ... for you big boy,” the commission said.


Shares Fall

Barclays fell as much as 3.4 percent in London trading today after tumbling 16 percent yesterday as U.K. lawmakers put pressure on Chief Executive Officer Robert Diamond. Prime Minister David Cameron said that the bank has questions to answer, while Ed Miliband, leader of the opposition Labour Party, has demanded a criminal investigation. Shares in Royal Bank of Scotland Group Plc, which is also being investigated for suspected Libor manipulation, dropped 11 percent.

Chancellor of the Exchequer George Osborne gave the first indication that there could be a criminal investigation in the U.K. when he addressed lawmakers yesterday and said British fraud prosecutors are now involved in the probe. The Serious Fraud Office is in contact with the Financial Services Authority and is considering whether to open a formal investigation, SFO spokesman David Jones said in an interview.

As part of its settlement, the CFTC ordered Barclays to amend how it sets Libor. Submissions should be based on actual trades if possible. Where no trades have taken place, the rate-setter can consider factors including how much competitors paid to borrow and market conditions, the CFTC said.

Rate-setters should be prohibited from “improper communications” and not work within earshot of derivatives traders, according to the commission. Barclays must keep extensive records on all its Libor submissions, including details on who the rate-setter was and how the figure was derived. The bank must also undergo annual audits and be willing to provide data to regulators on demand.

The CFTC requirements will provide a blueprint for what might be required of other banks once the BBA completes its review, said Owen Watkins, a former regulator at the FSA.

“You’ve got to have everybody playing the game by the same rules,” said Watkins, now a lawyer at Lewis Silkin LLP in London. “It’s like playing baseball with some guys throwing proper baseballs, while some guys throw golf balls.”


‘Serious Implications’

The Barclays settlement has “extremely serious implications, which need to be carefully considered,” the BBA said June 27 in an e-mailed statement. “The investigation findings will be fully included in the current review of Libor.”

Joseph Eyre, a spokesman for the U.K.’s Financial Services Authority, which levied the fine against Barclays along with the CFTC and the U.S. Justice Department, said “the BBA’s review is continuing and we will consider any recommendations arising from that exercise.”

The proposals may not go far enough, said Rosa Abrantes-Metz, an economist with Global Economics Group, a New York-based consulting firm, and an associate professor at New York University’s Stern School of Business.

“You will have some unease going forward if they do not impose some drastic changes,” said Abrantes-Metz, the co-author of a 2008 paper on Libor manipulation. “We need to have Libor reflect true borrowing costs and I just don’t see any more efficient way to do so but to base it on actual borrowing costs.”

The market isn’t going to settle for “the trust-me approach,” said Ron D’Vari, CEO of New York-based advisory firm NewOak Capital LLC and a former BlackRock Inc. managing director. “Changing wheels while driving is tough, but it has to be done.”

Diamond has agreed to appear at a meeting of U.K. lawmakers to highlight “what we have done and are doing to put things right,” he said in a letter yesterday to Andrew Tyrie, chairman of Parliament’s cross-party Treasury Committee.

“I appreciate that the nature of the settlements disclosed yesterday raises many questions, and I welcome the opportunity to provide answers,” Diamond wrote.

The BBA, which has overseen Libor for 26 years, created a steering group of bankers and regulators in March to consider reforms in light of the probes. The BBA was aware that banks including Barclays were low-balling their Libor submissions during the financial crisis to avoid the perception they were struggling to borrow cash, according to CFTC documents.

In an April 2008 phone call, a senior Barclays manager told a BBA representative, “We’re clean, but we’re dirty-clean, rather than clean-clean,” according to the CFTC report. The BBA employee responded, “No one’s clean-clean.”


Incremental Changes


Barclays is on the BBA steering committee reviewing Libor. The bank’s chairman, Marcus Agius, is also chairman of the BBA. Other lenders on the steering committee include Credit Suisse Group AG, HSBC Holdings Plc, Lloyds Banking Group Plc and Royal Bank of Scotland, all of which are being investigated as part of Libor probes. Spokesmen for the banks declined to comment.

Three members of the steering committee interviewed by Bloomberg News this month said changes to Libor would be incremental because structural modifications in how the rate is calculated could invalidate trillions of dollars of contracts and result in litigation. They ruled out stripping the BBA’s oversight and scrapping the survey system in favor of a rate based entirely on actual trades.

“You wouldn’t ask for someone’s opinion on the closing price of a share when there is an actual price available,” said Daniel Sheard, chief investment officer of GAM U.K. Ltd., which manages about $60 billion in assets. “What better way to restore credibility than having a transaction-based index?”

The British government will emphasize to the BBA at the steering group’s next meeting that only drastic changes will suffice, according to a person with knowledge of the matter, who asked not to be identified because the talks are private. Chancellor of the Exchequer George Osborne, speaking to lawmakers in London yesterday, said the FSA is “committing significant resources” to investigate “systemic failures” over the manipulation of Libor.

PFP Group’s Price said he’s skeptical that the BBA review or increased oversight by regulators will improve Libor.

“Whenever you’ve got a regulator battling against well-paid bankers, we know who’s likely to win,” Price said. “I would feel better if some completely independent body was just compiling data from the banks and just spitting out a number.”


Bloomberg News


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