On Thursday, Dec. 14, 2006, a derivatives trader at Barclays (NYSE: BCS) emailed a trader on the money markets desk, who we'll call Ted. It read: "For Monday we are very long 3m cash here in NY and would like the setting to be set as low as possible...thanks." The email was followed by another, this time from a fellow money markets trader urging, "You heard the man."
The second money markets trader then emailed the derivatives trader back, confirming that Ted "will take notice of what you say about a low 3 month."
Ted did indeed take notice. Two seconds after the final email, Ted set a calendar reminder on his desktop for the following Monday that simply said: "USD 3mth LIBOR DOWN." As promised, when Monday rolled around, Ted delivered a fixed submission to Thomson Reuters, which tabulates LIBOR for the British Bankers Association. As a result, Ted affected a market worth hundreds of trillions of dollars and relied on by companies all over the globe.
Digesting LIBOR
Ted was among numerous Barclays money market traders who made submissions for the calculation of LIBOR, a central benchmark lending rate for banks and companies around the world.
LIBOR, which stands for "London Interbank Offered Rate," is supposed to represent the interest rate at which major banks can borrow from each other. For instance, if Barclays wanted to borrow money for three months from Bank of America (NYSE: BAC), what rate would Barclays have to pay? Traders in Ted's position at major banks around the world are responsible for submitting their best estimate of what that rate is. The highest and lowest few of those submissions are then tossed and the rest averaged out to get to the final LIBOR rate.
LIBOR = a financial markets cornerstone
You may be tempted to gloss over this whole ordeal because of the "London" in LIBOR ("We're in America damnit!") and the fact that some of this sounds a bit esoteric. But in an era of media overhype of nearly everything, this is a truly market-shaking scandal.
If you need a view into just how crucial LIBOR is here in the U.S., then you don't need to look very hard. Investors reading Rite Aid's quarterly report filed on Tuesday may have noted that its credit facility is priced based on LIBOR -- specifically borrowings cost the company "between LIBOR plus 3.25% and LIBOR plus 3.75%." Also on Tuesday, Prospect Capital Corp (Nasdaq: PSEC) -- a business development company that lends to and invests in medium-sized businesses -- submitted a filing for new debt. A perusing of that filing reminds investors that when Prospect makes investment loans, it often prices those loans based on LIBOR.
Look further and you'll see it everywhere. Coca-Cola has more than $1 billion in LIBOR-based debt, UPS has multiple credit facilities priced based on LIBOR, and Chesapeake Energy has more than $5 billion in credit available that can be priced based on LIBOR. When you hear global companies like Coke talk about taking interest rate derivative positions as a hedge, LIBOR is typically part of those transactions. And of course LIBOR is front and center when banks are doing business with each other.
So Barclays traders manipulating LIBOR rates -- or, at least, attempting to do so -- is not some backwater finance footnote that you can safely pass over. This is the stuff that is constantly pumping through the veins of the global capital markets.
Ted wasn't alone
Ted and his two pals highlighted above were far from the only Barclays traders taking part in this type of manipulation. In fact, the U.K.'s Financial Services Authority's report on the scheme provides some pretty interesting reading -- if for no other reason than highlighting just how brazen these traders were in putting in their "fixes."
A few of my favorite exchanges:
Trader One: "If it's not too late low 1m and 3m would be nice, but please feel free to say 'no' ... Coffees will be coming your way either way, just to say thank you for your help in the past few weeks."
Submitter One: "Done...for you big boy."
---
Trader Two: "The big day [has] arrived... My NYK are screaming at me about an unchanged 3m libor. As always, any help wd be greatly appreciated. What do you think you'll go for 3m?"
Submitter Two: "I am going 90 altho 91 is what I should be posting."
Trader Two: "[...] when I retire and write a book about this business your name will be written in golden letters [...]."
Submitter Two: "I would prefer this [to] not be in any book!"
---
Submitter Three: "Hi All, Just as an FYI, I will be in noon'ish on Monday [...]"
Trader Three: "Noonish? Whos going to put my low fixings in? hehehe"
Submitter Three: "[...] [X or Y] will be here if you have any requests for the fixings."
What's next?
Barclay's response to this has been a bit comical. After being hit with big fines from the FSA and the U.S. Commodity Futures Trading Commission, Barclays' executive management said they'd go without bonuses for the year -- nice move, fellas.
A normal, reasonable person probably would have realized that for an offense of this magnitude that action would be far short of what was required. Barclays didn't get the memo. Only as pressure continued to mount did the chairman of the bank offer to step down. It took some further serious cajoling and late-night calls from high-ranking regulators to finally get CEO Bob Diamond to call it quits as well.
But this is far from over.
Barclays, of course, is not done being dragged across the coals. But now the whole system of setting LIBOR has to be up for discussion -- for a rate so crucial to the global financial system it's laughable how effortlessly Barclays' traders lobbed in fixed submissions.
Perhaps the even bigger question, though, is whether or not Barclays really is the only place where this was going on. When it comes to U.S.-dollar-based LIBOR, rates are set based on submissions from 18 banks, Barclays plus:
- Bank of America
- Bank of Tokyo-Mitsubishi UFJ
- BNP Paribas
- Citibank (NYSE: C)
- Credit Agricole
- Credit Suisse
- Deutsche Bank
- HSBC
- JPMorgan Chase (NYSE: JPM)
- Lloyds Banking Group
- Rabobank
- Royal Bank of Canada
- Societe Generale
- Sumitomo Mitsui Banking
- The Norinchukin Bank
- The Royal Bank of Scotland
- UBS
Regulators are now taking a closer look at many of these banks for similar transgressions.
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