F&C Y3 Q4 1213 CASE 1 Royal Bank of Scotland and Libor The wrong stuff A widening scandal threatens to suck in more banks, and ruin more careers Feb 9th 2013 |From the print edition The Economist THEY were said to be among the most talented of their generation, recruited after exhaustive interviews and gruelling internships. They worked at firms prepared to spend small fortunes to attract and retain them lest they take their skills elsewhere. Yet the moral bankruptcy of traders implicated in the rigging of the London Interbank Offered Rate (LIBOR), one of the world’s most important interest rates, is matched only by the incompetence with which they covered their tracks. Take traders at the Royal Bank of Scotland (RBS), who left a trail of evidence in a trove of e-mails and audio recordings detailing how they set about trying to manipulate LIBOR, even after they knew investigators were looking into the issue. “We’re just not allowed to have those conversations over Bloomberg anymore,” said one trader, laughingly, in a call to another who a little earlier had asked in writing for a rigged rate. “Its [sic] just amazing how libor fixing can make you that much money,” was the verdict of another trader. These exchanges, and many others, were part of a settlement announced on February 6th in which RBS admitted to rigging rates. It agreed to pay fines of $475m to American regulators and another £87.5m ($137m) to Britain’s Financial Services Authority. By the arcane mathematics determining the severity of regulatory fines, RBS is adjudged not to have been as bad an offender as UBS, which last year agreed to pay penalties of $1.5 billion, but is being dealt with a bit more harshly than Barclays, which paid fines of £290m. Regulators said they found attempts to rig LIBOR hundreds of times in at least four and a half years at RBS, compared with the “thousands” alleged in the case of UBS. There is now a sense of routine about these settlements: the early leaks, the embarrassing e-mails, the big fines. That can make LIBOR seem like just another problem for banks to manage. RBS’s share price rose on the day of its settlement. Even setting aside the threat from litigation, that is to underplay the import of the scandal. First, whether they had any knowledge of wrongdoing at their bank or not, the executives who were in charge of investment banking at the time rate-rigging took place find themselves under pressure to leave. At Barclays that meant the departure of Bob Diamond, the bank’s former chief executive. At UBS almost the entire leadership team at the investment bank has changed (although many were undone by a separate rogue-trading scandal). At RBS John Hourican will leave as head of the investment-banking arm, despite not being directly implicated in the LIBOR affair. If regulators are demanding the heads of whoever was running the investment bank at the time of wrongdoing, whether they were complicit or not, that could make life uncomfortable for executives at banks yet to go through the regulatory wringer. On February 6th, for example, Deutsche Bank reportedly suspended several traders over the alleged manipulation of EURIBOR, a cousin of LIBOR. If Deutsche ends up in the same spotlight as RBS, Barclays and UBS, awkward questions will surely be asked of Anshu Jain, the co-chief executive of Deutsche Bank and the ex-head of its investment bank.

Holding executives accountable is not without risks: good people may be forced out of banks when they need them most. But it does focus the mind. The second, lasting effect of the LIBOR scandal is to make bosses pay more attention to compliance and culture. “A lot of the bank CEOs I talk with don’t worry that regulatory change could shut them down,” says Ted Moynihan of Oliver Wyman, a consultancy. “But they see the conduct issue as potentially existential.” The scandal has also hardened the views of regulators and politicians. The inadequate risk controls at RBS will reinforce a perception that some banks have become not merely too big to fail, but too complex to manage. UBS is slimming its investment bank radically. Barclays is planning to reduce the size of its wholesale bank. RBS may face pressure to shrink its investment bank further. The storm around LIBOR is less intense than it was but its consequences are immense.

The LIBOR probes An expensive smoking gun Court documents shed light on how LIBOR was allegedly manipulated Apr 14th 2012 |From the print edition The Economist

Other suggestions on how to improve LIBOR welcome IT IS supposed to be constructed using banks' own honest estimates of what it costs for them to borrow money. But regulators around the world suspect that LIBOR (the London inter-bank offered rate), a financial benchmark that is set every day by collating these estimates, has been subject to manipulation. Little information has been publicly released by the regulators that are investigating. But Canadian and American legal documents seen by The Economist paint a picture of what is alleged. It is not pretty. Suspicions that something was wrong with LIBOR were aroused in 2008 when financial risks began to pick up but the benchmark, which ought to have ticked upwards too, did not move. That same year a group of American academics circulated a paper showing that banks' individual estimates of their borrowing costs were surprisingly close, given their different levels of risk. That suggested something fishy but was not conclusive proof, according to Rosa Abrantes-Metz of New York University Stern School of Business, one of the paper's authors.

A case brought by the Canadian Competition Bureau provides harder evidence that some banks' submissions were being manipulated. The court documents suggest that a group of traders regularly contacted one another to discuss how to influence the yen LIBOR rate. If true, that would have breached two principles. One is that traders from different banks should not be aligning their positions in this way. The other is that traders are supposed to be separated from staff within the same bank who estimate LIBOR. The case filing summarises messages sent by “Trader A”, an employee of an unnamed whistleblowing bank. Many institutions are implicated in the document but the following excerpt cites RBS to show how the alleged scheme worked: “Trader A explained to one RBS IRD trader who his collusive contacts were and how he had and was going to manipulate Yen LIBOR. Trader A also communicated his trading positions, his desire for a certain movement in Yen LIBOR and gave instructions for the RBS IRD trader to get RBS to make Yen LIBOR submissions consistent with Trader A's wishes. The RBS IRD trader acknowledged these communications and confirmed that he would follow through. Trader A and the RBS IRD trader also entered into transactions that aligned their trading interests in regards to Yen LIBOR.” RBS says that it has “legal and factual defences” against such claims. The Canadian case opens a window into how LIBOR manipulation may have happened. Civil cases brought by banks' customers in America suggest who might have suffered if the rate was being gamed. These cases can be grouped into four types, according to Bill Butterfield and Anthony Maton of Hausfeld, a law firm. First, there are large individual investment firms seeking damages on their own. The other three types of case are brought by customers acting as groups. One group includes traders who were on the wrong side of LIBOR bets. A second group includes investors in large companies' LIBOR-linked debt who may have lost out on interest payments if LIBOR was set too low. The final group is made up of customers that bought interest-rate swaps from banks. This group includes the city of Baltimore, which is represented by Hausfeld and whose case is especially revealing. American cities borrow to finance the construction of large-scale public works like roads and sewerage systems. They can borrow most cheaply at floating rates but this option lacks the stability that fixed-rate borrowing gives. Swaps can help them get the best of both worlds. The city first borrows at a low floating rate. It then buys an interest-rate swap from a bank. Under the swap deal it receives a LIBOR floating rate which cancels out the payments it must make to investors in its debt. In exchange the city pays the bank a fixed rate. Baltimore entered into over $100m in interest-rate swaps, according to case documents. Lower LIBOR-linked payments to the city would have meant less money to cover the outgoing fixed-rate payments. If LIBOR was artificially suppressed, the city would have been losing millions annually. If the case is upheld, damages could be big. The American cases are being pursued under “class action” litigation. This means that if Baltimore's case is upheld other cities sold the same products will also be able to claim damages. Across America 40 states allow municipalities to enter into swap agreements. The total estimated amount in 2010 was $250 billion-500 billion, according to an IMF paper. What's more, cases are being brought under the Sherman Act, America's antitrust law, which allows for triple damages. Assume the worst and damages for American cities alone could go as high as $40 billion.