The Ledger
Liam Vaughan
Gavin Finch
LONDON | Every morning, from his desk by the bathroom at the far end of Royal Bank of Scotland Group's trading floor overlooking London's Liverpool Street station, Paul White punched a series of numbers into his computer.
White, who joined RBS in 1984, was one of the employees responsible for the firm's submissions to the London interbank offered rate, or Libor, the global benchmark for more than $300 trillion of contracts, from mortgages and student loans to interest-rate swaps. Behind him sat Neil Danziger, a derivatives trader at the bank since 2002. On the morning of March 27, 2008, Tan Chi Min, Danziger's boss in Tokyo, told him to make sure the next day's submission in yen would increase.
"We need to bump it way up high, highest among all if possible," Tan, known by colleagues as "Jimmy," wrote in an instant message to Danziger, according to a transcript made public by a Singapore court and reviewed by Bloomberg before being sealed by a judge at RBS's request.
The trader typically would have swiveled in his chair, tapped White on the shoulder and relayed the request, people who worked on the trading floor said. Instead, as White was away that day, Danziger input the rate himself.
The next morning RBS said it paid 0.97 percent to borrow in yen for three months, up from 0.94 percent the previous day. The Edinburgh-based bank was the only one of 16 surveyed to raise its rate. If it had lowered its submission in line with others, the cost of borrowing in yen would have fallen one-fifth of a basis point, or 0.002 percent, according to data compiled by Bloomberg. Even that small a move could mean a gain of $250,000 on a position of $50 billion.
Events like those that took place on RBS's trading floor, across the road from Bishopsgate police station and Dirty Dicks, a 267-year-old public house, are at the heart of the biggest and longest-running scandal in banking history.
For years, traders at RBS, Barclays, UBS, Deutsche Bank, Rabobank Groep and other firms that stood to profit worked with employees responsible for setting the benchmark to rig the price of money, according to documents obtained by Bloomberg and interviews with two dozen current and former traders, lawyers and regulators. Those interviews reveal how the manipulation flourished for years, even after bank supervisors were made aware of the system's flaws.
The conspiracy wasn't confined to low-level employees. Senior managers at RBS, Britain's largest publicly owned lender, knew banks were systematically rigging Libor as early as August 2007, transcripts of phone conversations obtained by Bloomberg show. Some traders colluded with counterparts at other banks to boost profits from interest-rate futures by aligning their submissions. Members of the close-knit group knew each other from working at the same firms or going on trips organized by interdealer brokers such as ICAP to Chamonix, a French ski resort, or the Monaco Grand Prix.
"We will never know the amounts of money involved, but it has to be the biggest financial fraud of all time," said Adrian Blundell-Wignall, a special adviser to the secretary general of the Organization for Economic Cooperation and Development in Paris. "Libor is the basis for calculating practically every derivative known to man."
Now, more than five years after alarms first sounded, regulators and prosecutors are closing in. Three people, including a former trader at UBS and Citigroup, were arrested in London this week in connection with the probe into rate manipulation, the first apprehensions in an investigation involving more than half a dozen agencies on three continents.
Barclays paid a record 290 million-pound ($468 million) fine in June to settle with regulators, and the London-based lender's three top executives, including Chief Executive Officer Robert Diamond, departed after criticism by bank supervisors and politicians. Other firms, including RBS and Zurich-based UBS, are negotiating settlements, according to people with knowledge of the discussions. UBS may face a fine of more than $1 billion from U.S. and British regulators within days, a person with knowledge of the investigation said today. Spokesmen for Barclays, RBS and UBS declined to comment.
The industry faces regulatory penalties of at least $8.7 billion, according to Morgan Stanley. The European Union is leading a probe that could see banks fined as much as 10 percent of their annual revenue. Dozens of lawsuits have been filed in the United States and Britain claiming losses on products pegged to Libor.
The scandal demonstrates the failure of London's two-decade experiment with light-touch supervision, which helped make the British capital the biggest trading hub in the world. In his 10 years as Chancellor of the Exchequer, Gordon Brown championed this approach, hailing a "golden age" for the City of London in a June 2007 speech. Even after the FSA pledged to toughen its rules following the 2008 financial crisis, supervisors failed to act on warnings that the benchmark was being manipulated.
Regulators have known since at least August 2007 that banks were using artificially low Libor submissions to appear healthier than they were. That month, a Barclays employee in London e-mailed the Federal Reserve Bank of New York, questioning the numbers that other banks were inputting, according to transcripts published by the New York Fed.
Nine months later, Tim Bond, then head of asset allocation at Barclays's investment bank, publicly described the Libor figures as "divorced from reality," saying in a Bloomberg Television interview that firms were routinely misstating their borrowing costs to avoid the perception they were facing stress.
The New York Fed and the Bank of England say they didn't act because they had no responsibility for oversight of Libor. That fell to the British Bankers' Association, the industry lobbying group that created the rate and largely ignored recommendations from central bankers after 2008 to change the way the benchmark is computed. Regulators also were preoccupied with the biggest financial crisis since the Great Depression, and forcing banks to be honest about their Libor submissions might have revealed they were paying penalty rates to borrow.
Libor is calculated daily through a survey of banks asking how much it costs them to borrow in different currencies for various durations. Because it's based on estimates rather than actual trade data, the process relies on the honesty of participants. Instead, derivatives traders at banks around the world sought to influence their firms' Libor submissions and managers sometimes condoned the practice, according to documents and transcripts of instant messages obtained by Bloomberg.
Some former regulators say they were surprised to learn about the scale of the cheating.
"Through all of my experience, what I never contemplated was that there were bankers who would purposely misrepresent facts to banking authorities," Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, said in a phone interview. "You were honor-bound to report accurately, and it never entered my mind that, aside from a fringe element, it would be otherwise. I was wrong."
Sheila Bair, a former acting chairman of the U.S. Commodity Futures Trading Commission and chairman of the Federal Deposit Insurance Corp. from 2006 to 2011, said the scope of the scandal points to the flaws of light-touch regulation.
"When a bank can benefit financially from doing the wrong thing, it generally will," Bair said in an interview. "The extent of the Libor manipulation was eye-popping."
Libor debuted in 1986, the year British Prime Minister Margaret Thatcher's so-called "Big Bang" program of financial deregulation fueled a boom in London's bond and syndicated-loan markets. It was intended to be a simple benchmark that borrowers and lenders could use to price loans.
In 1997, the Chicago Mercantile Exchange switched the rate used in pricing Eurodollar futures contracts to Libor, solidifying its position as the principal benchmark for the swaps market, which by June 2012 had a notional value of $639 trillion, according to the Bank for International Settlements.
That decision created a temptation for swaps traders to game Libor, particularly in the days before International Money Market or IMM dates, when three-month Eurodollar futures settle. The value of traders' positions, often billions of dollars, was affected by where the dollar Libor rate was set on the third Wednesdays of March, June, September and December.
The manipulation of Libor was discussed openly at banks.
"We have an unbelievably large set on Monday," one Barclays swaps trader in New York e-mailed the firm's rate- setter in London on March 10, 2006. "We need a really low three-month fix, it could potentially cost a fortune."
The rate-setter complied with the request, according to Britain's Financial Services Authority, which published the e- mail following its investigation of the bank's role.
Each day, the BBA asks banks to estimate how much it would cost them to borrow in 10 currencies for periods ranging from overnight to one year. The top and bottom quartiles of quotes are excluded, and those left are averaged and made public before noon in London. Submissions from contributing banks also are published. The dollar Libor panel consists of 18 banks, while the one for sterling has 16, and 13 firms set the yen rate.
It didn't take a conspiracy involving large numbers of traders at different firms to move the rate. By nudging their submissions, traders at a single bank could influence where Libor was fixed. Even inputting a rate too high to be included could push up the final figure by sending a previously excluded entry back into the pack. A move in Libor of less than 1 basis point, or one-hundredth of a percentage point, could be valuable for traders managing billions of dollars in swaps.
"If you have a system like Libor, where highly subjective quotes are built into the process, you have a lot of opportunity for manipulation," said Andrew Verstein, a lecturer at Yale Law School in New Haven, Conn., and co-author of a paper on Libor rigging to be published in the Winter 2013 issue of the Yale Journal on Regulation. "You don't need a cartel to make Libor manipulation work for you. It certainly wouldn't hurt, but it didn't have to happen."
At UBS, Deutsche Bank, Barclays, Rabobank, RBS and JPMorgan Chase, rate-setters were given no training or guidelines for making submissions, according to former employees who asked not to be identified because investigations are continuing. At RBS and Frankfurt-based Deutsche Bank, derivatives traders on occasion made their firm's submissions, they said. Spokesmen for all the banks declined to comment.
It wasn't until the following year, prompted by a March 2008 report by the Bank for International Settlements and an April article in the Wall Street Journal suggesting banks were lowballing their submissions, that the New York Fed and the Bank of England asked the BBA to review the rate-setting process.
In June 2008, New York Fed President Timothy Geithner sent a memo to Bank of England Governor Mervyn King and his deputy, Paul Tucker, putting forward a list of recommendations for fixing Libor, including increasing the number of contributing banks, basing the rate on an average of randomly selected submissions and cutting maturities in which little or no trading took place.
Aside from creating a committee to review questionable submissions and promising to increase the number of contributors to dollar Libor, the BBA chose not to implement Geithner's suggestions. Angela Knight, then the group's CEO, said in a December 2008 statement that Libor could be trusted as "a reliable benchmark."
Privately, regulators were skeptical. As the BBA was drafting its proposals, King wrote to colleagues including Tucker on May 31, 2008, describing the group's response as "wholly inadequate," according to documents released by the Bank of England in July. Rather than press the BBA to change the way Libor was set, the Bank of England, the FSA and the New York Fed demanded that any references to them be removed from the BBA review, the emails show.
A spokesman for the Bank of England said Britain's central bank "had no supervisory responsibilities" for Libor at the time. The New York Fed also "lacked direct authority over Libor" and didn't want to be seen endorsing a private association's plan, according to Jack Gutt, a spokesman. The New York Fed continued to press for reform through 2008, he said.
Liam Parker, an FSA spokesman, referred to earlier comments FSA Chairman Adair Turner made to British lawmakers in July that the regulator was in contact with the CFTC at a "very early stage" in the U.S. commission's investigation. It's in the nature of such probes that one regulator takes the lead and others assist and decide at a later date whether to get "directly and formally involved," Turner said.
The BBA said in an email that it's working with the regulators "to ensure the provision of a reliable benchmark which has the confidence and support of all users."
By failing to act, regulators allowed rate-rigging to continue over the next two years. At RBS, the abuse was most pronounced from 2008 until late 2010, according to people close to the bank's internal probe. At Barclays, manipulation continued until the second half of 2009. Japan's financial services agency banned Citigroup from trading derivatives linked to Libor and Tibor for two weeks in January in punishment for wrongdoing that started in December 2009.
"It's not adequate for the authorities to say, 'We didn't have responsibility,"' said Paul Myners, a Labour Party member in Parliament's House of Lords and the British government's financial-services minister from 2008 to 2010. "It was a huge oversight by the regulators not to realize that Libor and other benchmarks were of such critical importance that they should fall within the regulatory ambit."
In the end, it was a U.S. regulator without any banking oversight that brought Libor rigging to a halt. Vincent McGonagle, a top enforcement official at the Commodity Futures Trading Commission in Washington, initiated a probe into Libor after reading the April 2008 Wall Street Journal story.
The CFTC sent letters to several banks that fall requesting information, according to a person with knowledge of the investigation. The commission decided it had the authority to act because Libor affects the price of commodities, including futures contracts that trade on the Chicago Mercantile Exchange.
Banks opened their own investigations after the CFTC inquiries. Barclays initially looked into allegations it had lowballed dollar Libor. It appointed Rich Ricci, then co-head of its investment bank, to oversee the inquiry. As the team sifted through thousands of pages of e-mail correspondence and transcripts of instant messages and phone conversations, it uncovered evidence that traders were manipulating the rate both up and down for profit, according to two people with knowledge of the probe.
The CFTC came to the same conclusion in late 2009 or early 2010, according to the person with knowledge of the commission's inquiry. It happened when Gary Gensler, who had been chairman for less than a year, stood in the foyer of his ninth-floor Washington office as Stephen Obie, acting head of enforcement at the time, played a Barclays tape of a conversation between traders and rate-setters, the person said.
"We had to vigorously pursue this," Gensler said in a Dec. 9 interview. "Sometimes practice in a market gets confused and over the line, but nonetheless it may still be illegal."
At RBS, managers condoned and sometimes encouraged rate- rigging by employees, according to Tan, who sued the bank for wrongful dismissal in Singapore in December 2011. Tan says executives including Nygaard and Kevin Liddy, global head of short-term interest-rate trading, were aware of the behavior.
Other RBS managers sought to manipulate the benchmark themselves. In an instant-message conversation on Dec. 3, 2007, Jezri Mohideen, then RBS's head of yen products in Tokyo, instructed colleagues in Britain to lower the bank's six-month Libor submission that day, according to a transcript of the discussion seen by Bloomberg.
RBS has fired four traders and suspended at least three others for alleged rate manipulation, according to a person with knowledge of the probe. Barclays has disciplined 13 employees and dismissed five, Ricci, now head of corporate and investment banking, told British lawmakers on Nov. 28.
More than 25 people have left UBS after the Zurich-based lender's internal probe, a person with knowledge of the investigation said last month.
Not until Barclays settled with regulators in June, five years after flaws in the rate-setting process emerged, did the British government order an inquiry into Libor. It recommended stripping the BBA of its oversight role, handing it to the Bank of England and introducing criminal sanctions for traders seeking to rig the benchmark rate.
"Governance of Libor has completely failed," FSA Managing Director Martin Wheatley, who led the review, said as he released the report. "This problem has been exacerbated by a lack of regulation and a comprehensive mechanism to punish those who manipulate the system."
The ubiquity of contracts pegged to Libor leaves banks vulnerable to lawsuits. Barclays was ordered by a British judge last month to release the names of all individuals involved in Libor-rigging at the bank after Guardian Care Homes, a Wolverhampton, England-based owner of about 30 homes for the elderly, sued the bank for 38 million pounds over interest-rate swaps that lost it money.
In Alabama, mortgage-holders have filed a class action in federal court alleging that 12 banks colluded to push Libor higher on the dates when repayments are set. The plaintiffs include Annie Bell Adams, a pensioner whose home was repossessed, and Dennis Fobes, a 59-year-old salesman of janitorial supplies whose house in Mobile is now worth less than his mortgage. He said he refinanced in 2006 with a $360,000 adjustable-rate mortgage linked to six-month dollar Libor.
"It's just another example of how the banks have manipulated everything in their power," Fobes said in a telephone interview. "I will fight them to the day I die to save my home."
Savers also are suing. The city of Baltimore and Charles Schwab Corp., the largest independent brokerage by client assets, have filed suits claiming banks colluded to keep Libor artificially low, depriving them of fair returns. At least 30 such cases are pending in federal court in New York.
"Our hope is that the exposure of this illegal conduct results in systemic changes in Libor that prevent similar abuses in the future," Sarah Bulgatz, a spokeswoman for Schwab, said in an e-mail.
In London, lawyers at Collyer Bristow, a 252-year-old firm, are working on a plan that would force banks to reimburse customers for any payments they made under derivatives contracts pegged to Libor. Three of the five partners on the financial- litigation team are working full time on Libor-related cases.
Stephen Rosen, who runs the practice, said clients who entered into interest-rate swaps with banks are entitled to cancel those contracts because manipulation was so entrenched. Swaps are contracts that allow borrowers to exchange a variable interest cost for a fixed one, protecting them against fluctuations in interest rates.
"It's possible on legal grounds to set aside the swap contract entirely, which could mean you can recover all the payments you've made under the swap," Rosen, who wears thick- rimmed glasses and speaks in clipped, precise tones, said in an interview at his office in a Georgian townhouse in the legal district of Gray's Inn. "The bank, when they entered into the swap, made an implied representation that Libor would not be unfairly manipulated."
Rosen said his clients include a publicly traded real estate company, three nursing homes and at least 12 more firms that bought Libor-linked interest-rate swaps from banks. He declined to identify them by name, citing confidentiality rules.
"The client will argue, 'Had you told me the truth — that you were fraudulently manipulating this rate — I would never have entered the contract with you,"' he said. "We are calling this the nuclear option."
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_ With assistance from Silla Brush in Washington, Andrea Tan in Singapore and Francine Lacqua, Lindsay Fortado and Jesse Westbrook in London.
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