In depth: Manipulating Libor - could it happen here?
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If such misconduct did occur, there are a number of legal avenues that may be open to address any such misconduct. Actions by the Financial Markets Authority, the Commerce Commission and possibly the Serious Fraud Office may all be possible.
Buddle Findlay wishes to thank the New Zealand Financial Markets Association (NZFMA) for its cooperation and assistance in supplying detailed information on the process for setting market reference rates in New Zealand. The NZFMA is New Zealand's professional body for financial markets and manages, calculates and distributes New Zealand official market reference rates and pricing services.
On 27 June 2012, Barclays Bank Plc and related entities (Barclays) announced a settlement with United Kingdom and United States regulators in relation to investigations into interbank rates, including Libor and Euribor. Under the terms of the settlement, Barclays agreed to pay penalties totalling over half a billion New Zealand dollars. In the ensuing fallout, Barclays' chairman and chief executive have resigned, the United Kingdom government has convened a parliamentary committee to examine professional standards in the banking industry, and further questions have been asked about the role of regulators and market reference rate-setting organisations.
What are Libor and Euribor?
The London Interbank Offered Rate (Libor) and the European Interbank Offered Rate (Euribor) are benchmark rates for short term interest rates. They represent the interest rates at which banks will lend to each other, and are provided for various currencies and for terms ranging from overnight to 12 months.
While there are some technical differences between the two, Libor and Euribor are basically calculated by averaging quotes submitted by a selection of leading banks. Those quotes are the lowest perceived rates at which each bank could obtain funding from the relevant interbank money market for a given maturity and currency. They are not necessarily based on actual transactions.
Libor and Euribor are calculated under the auspices of the British Bankers Association (http://www.bba.org.uk and http://www.bbalibor.com) and the European Banking Federation (http://www.ebf-fbe.eu and http://www.euribor-ebf.eu) respectively.
Libor and Euribor are key rates that are used globally as reference points for many types of transactions. These market reference rates have a direct impact on wholesale lending and interest rate derivatives, and more indirectly on retail lending, including mortgages and personal loans.
What did Barclay's do?
As part of its settlement, Barclays admitted several types of misconduct at various times, including submitting artificial quotes to benefit its own trading positions and those of third parties, and seeking to influence other banks' Libor and Euribor quotes to benefit its own trading positions.
For example, where Barclays has an overall trading position that would profit when interest rates were falling, lower Libor or Euribor rates would benefit it. Submitting artificially low quotes in this situation would distort Libor or Euribor, making them artificially low and thus benefitting Barclays.
Evidence of this behaviour includes emails obtained by regulators with quotes such as "Dude I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger! Thanks for the libor".
Barclays also submitted artificially depressed quotes in the midst of the global financial crisis to prevent negative media attention of its financial health. Because Libor and Euribor quotes represent a bank's own estimate as to the rates it could borrow money, submitting higher quotes than other banks could have been seen as a sign of financial problems. At the instigation of senior management, Barclays submitted depressed quotes in order to avoid such concerns.
Evidence of such dishonest behaviour included email quotes like "My worry is that we… are being seen to be contributing patently false rates. We are therefore being dishonest by definition and are at risk of damaging our reputation in the market and with the regulators".
In Barclays' settlement with the United Kingdom Financial Services Authority (FSA), it admitted breaching the FSA's Principles for Business, including failing to:
- Observe proper standards of market conduct
- Take reasonable care to organise and control its affairs responsibly and effectively and
- Conduct its business with due skill, care and diligence.
The United States Commodity and Futures Trading Commission (CFTC) found that Barclays violated various provisions of the Commodity Exchange Act (7 USC Chapter 1 (2006)), including:
- Transmitting false, misleading or knowingly inaccurate market information that would affect the price of a commodity
- Manipulating or attempting to manipulate the price of a commodity and
- Aiding and abetting the attempts of third parties to manipulate the price of a commodity.
Barclays has also entered into a non-prosecution agreement with the Department of Justice, and has been granted conditional leniency from the Antitrust Division of the Department of Justice in connection with potential United States antitrust (competition) law violations.
All the regulators gave credit to Barclays for being the first institution to provide extensive and meaningful cooperation to regulators. The penalties payable by Barclays were also substantially reduced due to its cooperation.
The investigations into Libor and Euribor are wider than Barclays. Regulators are conducting industry-wide investigations into the activities of other banks and individuals. Additionally, further regulation may result from government inquiries, and the British press has mentioned the possibility of multi-billion pound civil compensation claims.
Do we have this problem in New Zealand?
It is almost certain that New Zealand does not have this problem.
New Zealand's equivalent to Libor and Euribor is the New Zealand bank bill reference rate. This is commonly referred to as BKBM, the Thomson Reuters page reference on which the rate is published. The Operating Rules and Principles for setting the New Zealand bank bill reference rate are published by the NZFMA. The way in which the New Zealand bank bill reference rate is set differs substantially from Libor and Euribor. In fact, as early as March 2011, there were suggestions in the United Kingdom that the Libor rate be set in the same way as BKBM to make Libor more credible (Financial Times, 25 March 2011 subscription may be required).
In New Zealand, a two minute trading window is opened each business day at 10:30am. Contributing banks must submit rates that are representative of the price at which they have actually traded during that window. This is unlike Libor and Euribor, which are calculated from quotes or estimates that do not necessarily represent actual trades. The NZFMA publishes daily the bank bill reference rates, the rates submitted by each bank, and the transactions that took place during the two minute trading window (this information is freely available on its website). Because of this transparency, it would be immediately obvious if a rogue banker was attempting to manipulate the market by submitting rates that were incorrect or not representative of the price at which they have traded in the trading window.
Consequently, even if there were bankers in New Zealand who were inclined to act unethically in this regard, they would face a strong disincentive to try, and would almost certainly be caught if they did.
The New Zealand legal position
The sort of misconduct alleged in relation to Barclays is not likely to be feasible in New Zealand due to the differences in setting BKBM. In addition to the NZFMA's own rules and Code of Ethics and Code of Practice, if such misconduct did occur, there are a number of legal avenues that may be open to address any such misconduct. Actions by the Financial Markets Authority, the Commerce Commission and possibly the Serious Fraud Office may all be possible. Additionally, the Financial Markets Conduct Bill (FMCB) currently before the Commerce Select Committee will repeal and replace much of New Zealand's securities laws, changing the legal position still further.
New Zealand does not currently have an equivalent to the United Kingdom's general Principles for Business. It is possible that similar principles may be introduced as part of the proposed "market services licensing" regime under the FMCB. However, it is unclear whether any such principles would necessarily apply to banks in their role in providing information for market reference rate. Banking licences are issued under a separate regulatory regime under the Reserve Bank of New Zealand Act 1989 which does not provide for such general standards of market conduct.
New Zealand does, however, prohibit false and misleading conduct and information in relation to dealing quoted securities and certain other types of securities and derivatives under the Securities Markets Act 1988. For example, section 13 of the Securities Markets Act provides that a person "must not engage in conduct, in relation to any dealings in securities [including most derivatives], that is misleading or deceptive or likely to mislead or deceive". As many quoted and over-the-counter (OTC) derivatives will use BKBM or another market reference rate as an underlying rate, it may be that any misconduct in providing false or incorrect information as part of setting market reference rates would fall foul of this provision (although this would not deal with market reference rates used for other purposes, for example, lending).
This prohibition is carried over into clause 16 of the new FMCB. The FMCB will also provide a number of other related provisions.
Non-financial specific legislation may also be relevant. For example, the Crimes Act 1961 has widely-drafted prohibitions on false statements intended to cause loss to others, and the Fair Trading Act 1986 prohibits misleading or deceptive conduct and certain false or misleading representations. The Commerce Act 1986 is also likely to apply to some kinds of conduct, particularly if the conduct involves arrangements between competing banks. The Commerce Act prohibits arrangements or understandings that substantially lessen competition, including price fixing arrangements. An arrangement between competing banks that fixes, controls, or maintains the price of goods or services (for example, an arrangement to fix interest rates) would breach the Commerce Act. Similar prohibitions on price fixing and other types of cartel conduct are in place in other countries, and investigations into interbank rates by overseas competition authorities (such as the Department of Justice and European Commission) are therefore focusing on possible collusion between financial institutions.
Such misconduct in New Zealand would therefore likely be dealt with in a similar way to the CFTC and Department of Justice in the United States, rather than more general principles of business as was used by the FSA in the United Kingdom. That said, it is worth emphasising again that the different operation of New Zealand's market reference rates mean that it would be very difficult for the types of misconduct carried out by Barclays to happen here.
Buddle Findlay has one of the finest banking law teams in New Zealand, with expertise in all aspects of banking legal work. Buddle Findlay has particular strength and depth in financial markets and derivatives. Buddle Findlay is one of only two New Zealand firms that are members of ISDA. For further information about this article, please contact the NZFMA or one of Buddle Findlay's banking and derivatives experts - Simon Jensen, Adam Jackson, Peter Owles, Michael Dineen, Neil Russ or Jan Etwell.