Flaws in the way Libor is set allowed individual banks to manipulate the key global interest rate for profit for years, according to traders.
While employees allegedly tried to rig the benchmark for $500 trillion of securities worldwide, they didn’t need to conspire with counterparts at other firms to affect where the rate was set each day, as some regulators concluded, said the people, one of whom lost his job for trying to distort the rate. By nudging their own firms’ submissions up or down in small increments they could boost the value of their trading books or cut their losses, said the people, who asked not to be identified because regulators are still investigating the Libor-setting process.
Libor is determined by a daily poll carried out on behalf of the British Bankers’ Association that asks banks to estimate how much it would cost to borrow from each other for different periods and in different currencies. The rate, an indicator of the cost of money, is used to set prices for securities from mortgages to car loans. Similarly, Euribor, the euro-equivalent, is overseen by the European Banking Federation in Brussels.
“Trader C’s aim was therefore that Barclays’s submissions would be high enough to be excluded from the final average calculation, which could have affected the final benchmark,” the FSA said.
“The decision to trim the bottom and top quartiles in the calculation was taken to exclude outliers from the final calculation,” according to the BBA Libor website. “By doing this, it is out of the control of any individual panel contributor to influence the calculation.”
The trader’s principal duty is to help clients offset interest-rate risks or take bets on the direction of rates via swaps or futures. A company taking out a loan, for example, may wish to protect itself from an increase in rates by buying a so-called plain-vanilla swap, whereby it exchanges its variable interest payments for fixed ones.
Here’s how one bank could manipulate Libor, based on Verstein’s analysis: