Barclays’ has copped to an attempted manipulation of LIBOR. It has agreed to pay about $450 million to the UK’s FSA, the CFTC, and the USDOJ. The CFTC filing states that Barclays had two motives for its actions. First, when Barclays’ reports to LIBOR were high relative to other banks’ (which Barclays people referred to as having their head above the parapet) and thereby raising questions about the bank’s financial condition, it allegedly reduced reported rates in order to allay such fears. Second, the bank’s traders allegedly influenced rate submissions, and conspired with traders at other banks to change their submissions, in order to advantage derivatives positions.
As I noted in 2008, when the story first broke, the second possibility created substantial legal liability for banks like Barclays that submitted the false reports. Under the anti-manipulation law in effect in the US at the time, it was necessary to have specific intent to create an artificial price of something like the LIBOR-based Eurodollar futures contract. The emails divulged today suggest such a specific intent.
Perhaps crucially, the Order only finds that Barclay’s attempted to manipulate, not that it had in fact succeeded. This will be an important issue going forward. To prove manipulation, and crucially, to collect damages, it will be necessary to show that Barclay and other submitters of LIBOR quotes indeed distorted the index, that is, they caused an artificial price in a futures contract based on LIBOR or some other interest rate like Euribor.
Proving this will be a very data intensive exercise. Moreover, there are two distinct issues-the impact of manipulation on the final settlement price of the futures contract (which is based on LIBOR), and the impact of manipulation on futures prices prior to expiration. The second issue will prove more challenging than the first because the connection is more direct in the final settlement price. Even that will pose some issues, however, because of the necessity of identifying the “but for”, i.e., what interest rate should banks like Barclays have reported. This will necessarily require looking at actual interbank transactions, raising the question of how many such transactions there will be during periods of time of money market stress starting in 2007.
These issues are not impossible. Similar, and arguably even more challenging issues, were confronted in a class action lawsuit against those who misreported natural gas prices to publishers like Platts. (Full disclosure: I consulted with plaintiffs in that matter, and wrote a declaration in support of certain aspects of the plan of allocation of settlement monies.)
The whole fiasco does point out, yet again, the overriding importance of basing cash-settled indices on actual transactions, wherever possible.
This is becoming an important issue in oil markets as well, as “Price Reporting Agencies” like Platts and Argus are under great scrutiny. But oftentimes the problem is not amenable to easy solution. You can’t have a reliable transaction-based index that is not susceptible to manipulation if (a) there are few transactions, and/or (b) market participants have the option to report transactions. Pharonic pronouncements from regulators that PRAs make bricks without straw are futile.
None of these issues are new. I (and my colleagues at UH) dealt with them in 2003 in our efforts to create an “energy data hub” in the aftermath of the price reporting scandal post-Enron. Voluntary reporting is extremely problematic. Compulsory reporting (along the lines of one of the few salutary features of Frankendodd) is necessary (but not sufficient for some markets) to produce reliable price indices. Arranging this on an international market like oil seems virtually impossible to implement, let alone enforce.
This is the longer explanation behind my rather cryptic quote from this WSJ article from last week.
Going back to LIEBOR, the Barclays $450mm coughed up is the first fine, but it won’t be the last one. In the energy markets, the CFTC collected about $250 million: fines will be many multiples of that in LIBOR and Euribor and TIBOR and whatever. And believe it or not, the really big money will likely be in civil litigation, and the battles will be much more intense there as well, IMO.