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The LIBOR Scandal: A Never-ending Saga

The LIBOR Scandal: A Never-ending Saga

by Patrick J. Medeo

In the spring of 2008, the hot topic quickly became financial institutions’ relentless manipulation of the London Interbank Offered Rate (“LIBOR”) for the United States Dollars (“USD”), Yen, and other currencies. Now, nine years later, big banks are still fighting anti-trust and criminal lawsuits arising from the scandal. In fact, there is renewed interest as litigation continues to be a fierce battle. Following revelations to authorities that nearly all LIBOR panel banks had been manipulating one of the most important benchmark interest rates, a flurry of lawsuits led to the discovery that banks had reaped hundreds of millions, if not billions, of USD in illicit gains.

What’s more, in the ensuing global litigation, banks have paid billions of dollars in fines or settlement fees. In 2015, five major US banks, including JPMorgan Chase & Co., Barclays PLC and Citicorp, all signed onto parent level guilty pleas (where parent corporations pled guilty for subsidiary activity) worth over $2 billion USD.[1] And, more recently, the Department of Justice has filed criminal charges against two French bankers for their alleged roles in the scandal. With the suits that are still making headlines, there is good reason for the attention.[2]

A recent suit filed by the Federal Deposit Insurance Corporation (“FDIC”), on behalf of 39 failed US banks, indicates damages upwards of $400 billion against major banks in London. This follows the FDIC’s suit being moved into multidistrict litigation in the US; however, parts of the lawsuit are being dismissed on jurisdictional grounds in US Federal Court. With the US based litigation showing little indication of stopping, the scandal still may set legal and industry standards for years to come.

To properly appreciate why the LIBOR scandal is still making headlines, and why the figures in these lawsuits are so incredibly high, it is necessary to understand exactly what it is that LIBOR does and how it is set. The LIBOR is one of the most important of several benchmark rates[3] that banks use in order to price and set interest rates for a wide variety of lending and financial instruments.[4] When properly calculated, LIBOR helps create an industry benchmark rate that aids banks in lending and borrowing money to/from customers and pricing financial instruments at competitive and stable rates. When manipulated, it allows for banks to project financial security and rake in millions of dollars in illicit gains.

It’s important to remember that LIBOR is not a single figure, in fact there is a LIBOR for various currencies including the Yen, Dollar, Swiss Franc, and many others. In addition, different LIBOR rates are calculated for a number of different maturities.[5] These rates are set daily at approximately 11 a.m. UTC, local time in London. At this time, panel banks, in a process overseen by the British Banker’s Association (“BBA”), submit the rates at which they expect that they would pay to borrow money from other banks at that time. After the rate is submitted, Thomson Reuters processes the information by removing the highest and lowest figures reported and averaging the remainder. This process is completed almost entirely in London or outside of the United States; however, the figures and analysis are used globally, including in the United States, for financial transactions and lending activity. It is estimated that LIBOR rates impact around $800 trillion in securities and loans.

When the banks submit their rate to the LIBOR, part of what they are doing is projecting an image regarding their financial health. At that time though, the activity is just a self-reported figure, with no significant procedural or substantive oversight.  A low rate suggests that the bank is liquid with a strong balance sheet, which means that it is a low credit risk. Conversely, a high rate suggests poorer health, less liquidity and, thus a higher credit risk. The rates submitted also indicate current sentiment towards the general industry economic health. This is exactly where the issue in the manipulation comes from. If a bank is paying a low interest rate to borrow money, that means that their borrowing costs are lower which, overall, may seem to be a good thing. However, what happens when those rates are manipulated to be artificially low, giving the higher credit risk banks lower interest rates from unassuming banks that are lending or trading in reliance on the accuracy of those figures? The answer is part of the recipe for disaster from which the scandal arose.

After the economic downturn in 2007, many banks were far from being low risk and they found that by manipulating the LIBOR rate they could lower their borrowing costs and line their own pockets with the remainder. This was done primarily in two ways. One form of manipulation comes from the trading desks. In short, traders work together to move the benchmark interest rate, a basis point or two, for edge on a trade (edge is what traders typically call a competitive advantage over the market). From a capital market perspective, this is problematic; however, the issue raised in FDIC’s London claim is even more problematic.

The FDIC is claiming that the panel banks “lowballed”[6] their rates and subsequently were lent money at artificially low interest rates causing the plaintiff banks to collapse. This claim is based upon the theory that the panel banks colluded to report undervalued borrowing costs in order to make it appear that they would borrow at favorably low rates at a detriment to the rest of the banks. This projected to the market that the banks were financially stable, low credit risk borrowers while in reality they may have been the opposite. The $400 billion-dollar figure in the lawsuit represents the aggregate value of the banks that failed allegedly due to the LIBOR scandal.

Unsurprisingly, the LIBOR scandal is still making headlines nearly a decade later, given that the ramifications of the manipulation have yet to be fully determined. Even if the scandal is no longer front-page news, it is far from being fully realized. Between anti-trust and criminal litigation in both the US and UK, as well as the close tie to the underlying cause of the financial crisis, the LIBOR scandal may still provide interesting answers to puzzling legal questions of liability regarding wide spread conspiracy in the financial industry. One of the most frequent arguments that banks have relied on in seeking dismissal from US courts is the lack of jurisdiction over certain entities. This argument puts front and center interesting theories on the limits of courts jurisdictional reach. With the bulk of controversies already adjudicated in the United States, there are far reaching implications for just how far regulators and courts can reach out to haul financial institutions into court on an international scale.

[1] https://www.justice.gov/opa/pr/five-major-banks-agree-parent-level-guilty-pleas

[2] https://www.justice.gov/usao-edny/pr/two-international-bank-managers-charged-interest-rate-manipulation-scheme

[3] Other benchmark rates include MIBOR (Mumbai Interbank Offer Rate), SIBOR (Singapore), HIBOR (Hong Kong), and EURIBOR (Euro).

[4] Credit Default Swaps, which allow banks to insure against the default of loans underlying bundled mortgage securities, played a significant part in the 2007 financial crisis and are often priced on a probability model called the “LIBOR Curve”.

[5] A “maturity” is the date or point in time at which a financial instrument, such as a bond or loan, must be renegotiated or will cease to exist. LIBOR is offered in 7 maturities from 1 day to 12 months, for example a bank expects they can borrow money for 1 day (the “maturity”) at 1.184% interest.

[6] The term “lowballing” is specifically used regarding the LIBOR Rigging scandal to refer to the practice of submitting interest rates lower than those that the banks could actually borrow at in order to project stronger financial health and benefit trading books. See also; http://lexicon.ft.com/Term?term=lowball .