Depending on context, the word ‘fix’ can mean ‘set’ or ‘determine’, ‘manipulate’ or ‘rig’ as well as ‘repair’ or ‘correct’. ‘In a fix’ means to be in difficulty. In colloquial use, ‘fix’ is a dose of an addictive substance that is habitually consumed. The current furore surrounding manipulation of money market rates contains all these meanings and more.
In June this year, UK and American authorities fined UK’s Barclays Banks £290 million ($450 million) for manipulating key money market benchmark rates, such as the London Interbank Offered Rate, or Libor, and Euro Interbank Offered rates, or EuroIBOR.
Barclays’ chief executive officer (CEO) Robert E Diamond Jr and chief operating officer Jerry del Missier were forced to resign. Barclays’ chairman Marcus Agius resigned but agreed to remain temporarily to find a new CEO.
Libor originally reflected the rates at which banks in the euro-dollar market lent surplus liquidity to each other. Demand for a standard benchmark for instruments based on money market rates led to the creation of the British Bankers’ Association (BBA) Libor fixings, which commenced officially in 1986.
Libor is defined as: “The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time”. Each bank must submit a rate accurately reflecting its belief about its cost of funds, defined as unsecured interbank cash borrowings or fund raised through issuance of interbank certificates of deposit, in London as at the relevant time.
There are 150 different Libor rates published every day, covering 10 currencies (including US$, C$, A$, NZ$, Euro, £, yen and Swiss Francs) and 15 maturities (ranging from overnight rates to 12 months).
There are between 8 and 20 banks on each currency panel. Each bank provides its quote. The top and bottom 25% are ignored and the remaining quotes are averaged (the inter-quartile mean) to arrive at the quoted Libor. The process is overseen by the BBA but daily calculations are undertaken by Thomson Reuters, which publishes the rate after 11:00 am, generally around 11:45 am each trading day, London time.
The rates are a benchmark rather than a tradable rate. The actual rate at which specific banks will lend to one another varies. The rate also changes throughout the day.
Libor is used for loans, bonds (such as floating rate notes) and derivative transactions. The exact volume of transactions using Libor is unknown as most are over-the-counter (OTC) bilateral transactions. Estimates suggest that Libor is used to establish the interest costs of $10 trillion of loans, $350 trillion of OTC derivatives and over $400 trillion of euro-dollar futures and option contracts traded on exchanges.
Pre-2007, Barclays manipulated rates in order to obtain financial benefits. Subsequently, during the global financial crisis (GFC), Barclays manipulated rates due to reputational concerns.
The pre-2007 episode relates primarily to mismatches in banks’ asset and liabilities. For the most part, banks simultaneously borrow and lend money. In derivatives, they both receive and pay the same or similar rates. Mismatches may be deliberately created to increase profit. Mismatches also result from the natural flow of customer transactions.
Mismatches (known as reset risk) can be managed by entering into transactions such as reset swaps. Hedges are expensive and not always readily available. The incentive to manipulate rates for profit arises from these mismatches. The evidence is consistent with this pattern of activities.
On September 13, 2006, a trader in New York writes: “Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the libor fixing at 5.39 for the next few days. It would really help. We do not want it to fix any higher than that. Tks a lot”.
On October 13, 2006, a senior euro swaps trader states: “I have a huge fixing on Monday… something like 30bn 1m fixing … and I would like it to be very very very high… Can you do something to help? I know a big clearer will be against us… and don’t want to lose money on that one”.
On October 26, 2006, an external trader makes a request for a lower three-month US dollar Libor submission stated in an email to a trader at Barclays “If it comes in unchanged I’m a dead man”.
Traders sought to fix the rate sets to increase the firm’s profits and ultimately their own bonuses. Following the request of October 26, 2006, Barclays submitted a three-month US dollar Libor quote that was half a basis point lower than that the day before. The external trader thanked the Barclays’ trader: “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger”.
