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| {{a|casenote|{{image|Dramatic look|jpg|}}}}{{quote| | | {{a|disaster|{{image|Dramatic look|jpg|''[[Dramatic look gopher]] goes to the [[British Bankers’ Association]]'' {{vsr|2024}}}}{{Disaster roll|LIBOR}}}}{{quote| |
| {{drop|“T|he courts have}} for many years been developing and using a broad concept which at times has threatened to bring chaos rather than light to the solution of the legal problems it has affected. This concept enunciates the division between questions of law and questions of fact.
| | {{drop|“I|f the law}} supposes that,” said Mr. Bumble, squeezing his hat emphatically in both hands, “the law is a ass—a idiot. If that’s the eye of the law, the law is a bachelor; and the worst I wish the law is that his eye may be opened by experience—by experience.” |
| :—''{{plainlink|https://scholarship.law.wm.edu/facpubs/810/|What is a “Question of Law”?}}'', Arthur W. Phelps, 1949, bringing yet more chaos to the table.
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| {{drop|“I|f the law}} supposes that,” said Mr. Bumble,… “the law is a ass—a idiot. If that’s the eye of the law, the law is a bachelor; and the worst I wish the law is that his eye may be opened by experience—by experience.” | |
| :— Charles Dickens, ''Oliver Twist''}} | | :— Charles Dickens, ''Oliver Twist''}} |
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| | == LIBOR: deep background == |
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| ==== Banks have structural interest rate risk ==== | | ==== Banks have structural interest rate risk ==== |
| {{drop|T|he basic model}} of a bank is to borrow, short-term, at a low rate, and lend, long-term, at a high rate. ''Generally'' banks calculate interest on deposits, by which they borrow, at a [[Floating rate|floating]] rate and on term loans, by which they lend, at [[Fixed rate|fixed]] rates. There is a straightforward reason for this: [[Deposit|call deposit]]<nowiki/>s don’t have a term: they can be withdrawn at any time. All you can do is apply a prevailing daily rate.<ref>You could look at deposits as “rolling overnight term loans”. Their fixed interest therefore resets each day. Yes: there are such things as term deposits, but roughly 70% of deposits are overnight. (see ''{{Plainlink|https://www.bankofengland.co.uk/statistics/tables|Bank of England statistics}}'').</ref> On the other hand, most people who borrow for a fixed term want certainty on how much interest they must pay, so they prefer fixed interest. | | {{drop|T|he basic model}} of a bank is to borrow, short-term, at a low rate, and lend, long-term, at a high rate. Generally, banks calculate interest on deposits, by which they borrow, at a [[Floating rate|floating]] rate and on term loans, by which they lend, at [[Fixed rate|fixed]] rates. |
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| | There is a straightforward reason for this: [[Deposit|call deposit]]s don’t have a term; they can be withdrawn at any time. All you can do is apply a prevailing daily rate.<ref>You could look at deposits as “rolling overnight term loans”. Their fixed interest therefore resets each day. Yes: there are such things as term deposits, but roughly 70% of deposits are overnight. (see ''{{Plainlink|https://www.bankofengland.co.uk/statistics/tables|Bank of England statistics}}'').</ref> On the other hand most people borrow for a fixed term and want certainty on how much interest they must pay, so prefer fixed interest. |
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| | Since banks ''borrow'' in floating and ''lend'' in fixed, they have “''structural'' interest rate risk”. It is a natural function of how banks work. They want floating rates to be low, and to move lower. If they don’t manage this risk, things can get funky, fast. Just ask [[Silicon Valley Bank]]. |
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| Since banks ''borrow'' in floating and ''lend'' in fixed, they have “''structural'' interest rate risk”. It is a natural function of how banks work. They want floating rates to be low, and to move lower. If they don’t manage this risk, things can get funky, fast. Just ask [[Silicon Valley Bank]].
| | So knowing what that floating rate is, and managing it, is an important risk management function for the bank. A risk well managed is called a “return”. The floating rate is different from the central bank’s base rate, and moves daily in response to market conditions. |
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| So knowing what that floating rate is, and managing it, is an important risk management function for the bank. A risk well managed is called a “return”. The floating rate is different from the central bank’s base rate, and moves daily in response to market conditions:
| | Where does this “floating rate” come from, then? |
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| So, a foundational question: Where does this “floating rate” come from?
| | In the good old days, each bank worked out its own floating rates based on its own models, funding costs and market positioning. This process was neither transparent nor standardised. Rates could vary significantly between similar banks. As long as interest rates were not tradable instruments, this did not much matter to banks: they just told their customers what the floating rate was each day, and that was that. |
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| In the good old days, each bank worked out its own floating rates, based on its own models, funding costs and market positioning. This process was opaque and unstandardised. Rates could vary significantly between similar banks. | | In the early nineteen eighties, some [[First Men|bright sparks]] at [[Salomon Brothers]] figured out how to make interest rates into a tradable instrument. To standardise that instrument, the banks realised they would need a common way of describing how their interest rates change through time. A “benchmark”. |
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| ==== Chess club and the cool kids ==== | | ==== Chess club ==== |
| {{Drop|E|nter, in the}} nineteen eighties, the [[British Bankers’ Association]]. This was just the sleepy, city-grandees-in-a-smoke-filled-gentlemen’s-club-in-Threadneedle-Street of your imagination. Inasmuch as it ever did anything useful, the BBA compiled the “London Interbank Offered Rate” — “[[LIBOR]]” — sleepily, by inviting 18 major banks to, literally, ''phone in'' the rate at which they believed they could borrow in various currencies and maturities in the market each day. | | {{Drop|E|nter the}} the [[British Bankers’ Association]]. This was just the sleepy, city-grandees-in-a-smoke-filled-gentlemen’s-club-in-Threadneedle-Street of your imagination. It began to compile what it called the “London Interbank Offered Rate” — “[[LIBOR]]”. This was to be an objective distillation of all the major banks’ borrowing rates. |
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| The BBA would compile the submissions, “trim” off the top and bottom four, average the rest and publish the result as a set of daily LIBOR rates for each currency and maturity, before toddling off for a liquid lunch at the Garrick and a regular three o’clock tee time. | | The method the BBA chose to compile it was simple: it invited 18 major banks to |
| | literally, ''phone in'' what they believed they could borrow in various currencies and maturities in the market each day. The BBA would then compile the submissions, “trim” off the top and bottom four, average the rest and publish a set of daily LIBOR rates for each currency and maturity, before toddling off for a liquid lunch at the Garrick and their regular three o’clock tee time at Wentworth. |
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| You get the picture. | | You get the picture. |
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| With LIBOR published, the banks could then set its rates for call deposits, calculate suitable fixed rates for new term loans, and trade interest rate swaps by reference to this standardised “benchmark”. Happy, unadventurous stuff, carried out by happy, unadventurous people. Look: we don’t want to run the interest rate-setting crowd down, but before 2007, the LIBOR rate setting process was the after-school chess club: all the cool kids were out shagging, smoking weed and shorting structured credit. No-one cared much about LIBOR. | | With LIBOR published, the banks could then set their rates for call deposits, calculate suitable fixed rates for new term loans, and more importantly trade standardised interest rate instruments by reference to the new LIBOR “benchmark”. |
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| | Happy, unadventurous stuff, carried out by happy, unadventurous people. Look: we don’t want to run the interest rate-setting crowd down, but before 2007, the LIBOR rate setting process was like the after-school chess club: snoresville. All the cool kids were out shagging, smoking weed and shorting structured credit. None of the hepcats paid much attention to LIBOR. |
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| Now. It is one of JC’s [[Financial disasters roll of honour|axioms of financial scandal]] that [[Air crashes v financial crashes|''calumny happens where you least expect it'']]. This is because success in financial services is in large part about “[[edge]]”, and you find the most [[edge]] where no-one else is looking. In the lead up to the global financial crisis, no-one was looking very hard at LIBOR. | | Now. It is one of JC’s [[Financial disasters roll of honour|axioms of financial scandal]] that [[Air crashes v financial crashes|''calumny happens where you least expect it'']]. This is because success in financial services is in large part about “[[edge]]”, and you generally only find an [[edge]] where no-one else is looking for it. |
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| Tom Hayes was a cool kid (''metaphorically'': he wasn’t ''literally'' very cool at all). But he hung out in the chess club. He, and a bunch of other groovers, found some [[edge]] there, where no one was looking for it. No one bothered them and they didn’t do any harm — at least, not that anyone has been since able to point to. But they sent each other lots of [[embarrassing emails]].
| | ==== The cool kids ==== |
| | {{Drop|T|om Hayes was}} a cool kid (''metaphorically'': literally he has been described as “socially awkward”) but he hung out in the chess club. He, and a bunch of other groovers, found some [[edge]] there, where no one was looking for it. No one bothered them and they didn’t do a lot of harm — not, at least, that anyone has been since able to point to. But they sent each other lots of [[embarrassing emails]]. |
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| In any case, they made an effort to submit LIBOR rates that suited their derivatives trading positions and not, necessarily, their banks’ structural interest rate positions. | | In any case, they made an effort to submit LIBOR rates that suited their derivatives trading positions and not, necessarily, their banks’ structural interest rate positions. |
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| Another one of JC’s axioms: [[If you like sausages, don’t work in a smallgoods factory|''if you like sausages, don’t work in a smallgoods factory'']]. | | Another one of JC’s axioms: [[If you like sausages, don’t work in a smallgoods factory|''if you like sausages, don’t work in a smallgoods factory'']]. |
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| ==== Interest rate derivatives ====
| | As per the “basic banking model”, to manage its structural interest rate risk, a bank ''generally'' would want LIBOR to be low. But deposits are not the only show in town — there are other exposures to the interest rate market: notably, the new tradable instruments: [[interest rate swap]]s. |
| {{drop|A|s per the}} “basic banking model”, to manage its structural interest rate risk, a bank ''generally'' would want LIBOR to be low. But deposits are not the only show in town — there are other exposures to the interest rate market: notably, [[Interest rate swap mis-selling scandal|interest rate swap]]s. Swaps [[Swap history|emerged as an asset class in the early 1980s]], and there is a good argument that LIBOR — instituted in 1986 — emerged in response to demand in the burgeoning interest rate swaps market for a more standardised measure of floating rates.
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| | ==== Interest rate swaps ==== |
| | {{Drop|I|n an interest}} rate swap, the bank “swaps” interest rates with individual counterparties: it might, for an agreed period, pay one counterparty a fixed rate and receive from it a floating rate; with another it might pay floating and receive fixed. |
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| In an interest rate swap, the bank exchanges — “swaps” — interest rates with individual counterparties: it might, for an agreed period, pay one counterparty a fixed rate and receive from it a floating rate; with another it might pay floating and receive fixed.
| | Before the advent of swaps, the only way of getting exposure to interest rates was by borrowing and lending principal. This required a lot of money down.<ref>It is a [[a swap as a loan|misconception]] that interest rate swaps do not involve principal borrowing and lending, but that is a story for another day</ref> Interest rate swaps got popular, fast. There are now trillions of dollars in notional interest rate swaps outstanding on any day. |
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| Unlike basic banking, there is no structural bias to swap trading. If a bank swaps a five-year fixed rate for a five-year floating rate, and LIBOR then goes up, by definition the bank profits: the “[[present value]]” of its incoming floating rate will increase while the [[present value]] of its outgoing fixed rate stays the same. The dealer is therefore “[[in-the-money]]”. If it swapped floating for fixed in the same case, it would book a corresponding loss. | | Unlike basic banking, there is no structural bias to swap trading. If a bank swaps a five-year fixed rate for a five-year floating rate, and LIBOR then goes up, by definition the bank profits: the “[[present value]]” of its incoming floating rate will increase while the [[present value]] of its outgoing fixed rate stays the same. The dealer is therefore “[[in-the-money]]”. If it swapped floating for fixed in the same case, it would book a corresponding loss. |
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| While banks try to balance their books so their portfolio of customer swaps offset each other as far as possible, how they “position” the book might help manage the bank’s ''structural'' interest rate risk. | | While banks try to balance their books so their portfolio of customer swaps offset each other as far as possible, how they “position” the book might help manage the bank’s ''structural'' interest rate risk. |
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| We can see in any case that a swap trader who is “long” floating rates will wish floating rates to go higher. This prospect, we venture, was not wildly present in the minds of the Sir Bufton Tuftons who formulated the LIBOR rules defining how submitting banks should choose the rates they submit each day.
| | Under the “basic banking model”, a bank will always be “[[Axe|axed]]” for floating rates to be as low as possible. You would expect a basic bank’s LIBOR submissions to reflect that. But a swap trader who is “long” floating rates will wish floating rates to go ''higher''. |
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| | This prospect, we venture, was not wildly present in the minds of the Sir Bufton Tuftons who formulated the LIBOR rules that defined how submitting banks should choose the rates they submit each day. |
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| Under the “basic banking model”, a bank will always be “[[Axe|axed]]” for floating rates to be as low as possible. You would expect its submissions to reflect that. The question arose later, even though it did not arise then: when submitting a rate, what account should a bank take of its own derivatives trading book?
| | The question arose later, even though it did not arise then: when submitting a rate, what account, if any, may a bank take of its own derivatives trading book? |
| ==== The LIBOR Definition==== | | ==== The LIBOR Definition==== |
| {{drop|T|he [[UK Finance|BBA]]’s guidance}} came in the form of “Instructions to BBA LIBOR Contributor Banks”. The critical part of these — what the court called the “LIBOR Definition” — ran as follows: | | {{drop|T|he [[UK Finance|BBA]]’s guidance}} came in the form of “Instructions to BBA LIBOR Contributor Banks”. The critical part of these — what the court called the “LIBOR Definition” — ran as follows: |
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| {{Quote|“An individual BBA LIBOR Contributor Panel Bank will contribute ''the rate at which it could borrow funds'', were it to do so by asking for and then accepting inter-bank offers in reasonable market size just prior to 1100.”}} | | {{Quote|“An individual BBA LIBOR Contributor Panel Bank will contribute ''the rate at which it could borrow funds'', were it to do so by asking for and then accepting inter-bank offers in reasonable market size just prior to 1100.”}} |
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| On any day there would be a range of rates at which a bank ''could'' borrow. These might be firm offers from other lenders, good faith estimates or model outputs. There is an excellent [[subjunctive]] in there, by the way: “''were'' it to do so” implies that it need not ''actually'' do so. | | On any day there will be a range of rates at which a bank ''could'' borrow. These might be firm offers from other lenders, good faith estimates or model outputs. There is an excellent [[subjunctive]] in there, by the way: “''were'' it to do so” implies that that a submitting bank need not ''actually'' do so. |
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| Say the range of available rates on a given day was, as the court hypothesised, between 2.50% and 2.53%. Which of these was “the rate at which it could borrow funds”? Plainly, a submitter could not submit all of them. | | Say the range of available rates a bank sees on a given day is between 2.50% and 2.53%. Which of these is “''the'' rate at which it could borrow funds”? You can only choose one. |
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| The logical options (setting aside for now their legality) were:
| | Setting aside for a moment compliance with the LIBOR Definition, the possible avenues open to a bank in submitting a rate are: |
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| ''Pick an “available” rate'': Choose one rate from those that were genuinely available per the bank’s good faith enquiry as above. | | ''Pick an “available” rate'': Choose one of the rates from the range, as above. |
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| ''Manufacture a blended rate from the range'': Contrive some artificial rate from within that range, reflecting a weighted average, or some such thing. | | ''Manufacture a blended rate from the range'': Contrive some artificial rate from within that range, reflecting a median, a weighted average, or some such thing. |
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| ''Make one up'': Submit a rate that did not fall within the estimated range, whether lower or higher. | | ''Make one up'': Submit a rate that did not fall within the estimated range, whether lower or higher. |
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| “Making one up” plainly falls outside the scope of the LIBOR Definition. “Making a blended rate” does not quite conform to the text, but perhaps captures its spirit. But in any case, Hayes did neither of these things. “Picking one of the available rates” is what Hayes actually did. To an uncomplicated reading of the LIBOR Definition, Hayes fell squarely inside it. This was a rate at which the bank ''could'' borrow funds. | | “Making one up” plainly falls outside the scope of the LIBOR Definition. “Making a blended rate” does not quite conform to its text, but perhaps captures its spirit. |
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| The complication is that Hayes actively selected the available rate that best suited his derivative trading position. That is, he was guided by his desk’s commercial interest, and not, the bank’s “structural” commercial interest.
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| This is the crux of the case. Having this ulterior motive — dishonest in light of the ''proper basis for the submission of those rates'' so the Crown alleged — was an imprisonable conspiracy to defraud.
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| ====“A conspiracy to defraud”====
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| {{drop|H|ayes was indicted}} on the ancient [[common law]] offence of “conspiracy to defraud”. Criminal law minutiae, perhaps, but he was not charged with a statutory criminal offence under the [[Fraud Act 2006]]. That Act followed a Law Commission survey of the criminal law of fraud, which had also recommended ''abolishing'' common law conspiracy to defraud, because it was “unfairly uncertain, and wide enough to ''have the potential to catch behaviour that should not be criminal''”.<ref>{{plainlink|https://www.gov.uk/guidance/use-of-the-common-law-offence-of-conspiracy-to-defraud--6|Attorney General guidance to the legal profession on use of conspiracy to defraud}}, November 2012.</ref> The government did not follow the Law Commission’s recommendation.
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| “The government decided to retain it for the meantime, but accepted the case for considering repeal in the longer term.” <ref>Ibid.</ref>}}
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| In any case, common law conspiracy to defraud was not abolished, still hasn’t been, that is what Hayes was charged with.
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| Being a common law offence, elements of the offence are not sharply delineated — a good policy reason to abolish all common law crimes, but anyway<ref>Shout out to my buddies in Kiwiland, by the way, where all criminal offences were codified and all residual common law crimes abolished in 1961. Good job, Kiwis!</ref> — but it seems to be along the lines that ''there was an agreement between persons who intended to defraud someone by doing something dishonest with a likelihood of resulting loss, even if no loss eventually arose''.<ref>This is in JC’s non-expert words. Not a criminal lawyer. May be missing something.</ref>.
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| The crux: was Hayes ''dishonest'' when he submitted his LIBOR rates?
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| That, in turn, came down to whether Hayes “deliberately disregarded the “''proper basis''” for the submission of those rates”.
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| The first instance court did not really dwell on the meaning of the LIBOR Definition, but rather whether Hayes’ intentions when choosing the rate he submitted were to reflect “the bank’s genuine perception of its borrowing rate”.
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| The court framed its instructions to the jury as follows:
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| {{Quote|“1. Did Mr Hayes agree with any individual as named in the counts, to procure the making of a submission by a bank of a rate which was not that bank’s genuine perception of its borrowing rate for the tenor in question in accordance with the LIBOR definition but was a rate which was intended to advantage Mr Hayes’s trading?
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| :If the answer is No, Mr Hayes is not guilty on that Count. If the answer is Yes, proceed to Question 2.
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| 2. Was what Mr Hayes did dishonest by the ordinary standards of reasonable and honest people?
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| :If the answer is No, Mr Hayes is not guilty on that Count. If the answer is Yes, proceed to Question 3.
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| 3. Did Mr Hayes appreciate that what he was doing was dishonest by those standards?
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| :If the answer is No, Mr Hayes is not guilty on that Count. If the answer is Yes, Mr Hayes is guilty on that Count.”}}
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| Hayes was sent to prison for 14 years, though this was later reduced to 11. He was not the only one. A total of thirty-seven traders were prosecuted for interest rate benchmark manipulation in London and New York of whom nineteen were convicted and nine imprisoned.
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| This is interesting purely because of its scale — we’ll come to that — but also because of the fortunes of two Deutsche Bank submitters, also convicted for manipulating LIBOR in the United States in similar circumstances, who then appealed. There, too, the question boiled down to what the LIBOR Definition actually meant.
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| ====Meanwhile, in Gotham City====
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| {{drop|N|ow, an ocean}} away, an American appeals court had considered that very question in the matter of {{casenote|United States|Connolly and Black}},<ref>{{citer|United States|Connolly and Black|2d Cir. 2022|No. 19-3806|}}</ref> two Deutsche Bank submitters convicted for manipulating LIBOR.
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| Followers of current events may even know that the US courts overturned their convictions, considering the question before them to be one of ''fact'': the text of the “LIBOR Definition” as filtered through the prisms of grammar, usage, subject matter expert opinion and industry practice.
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| The question of law — whether the submitters were dishonest — depended a great deal on matters of ''fact'' — such as what did those submitting rates believe was permitted within the LIBOR Definition, and if that seemed far-fetched, what a reasonable person reading the definition would think it required.
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| The precise hypothetical question to which the LIBOR submitters were responding was at what interest rate “could” DB borrow a typical amount of cash if it were to seek interbank offers and were to accept. ''If the rate submitted is one that the bank could request, be offered, and accept, the submission, irrespective of its motivation, would not be false''.}}
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| This led the US courts to conclude that picking from a range of available rates, whatever your motivations for your choice could not be fraudulent. It was within the rules.
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| Buoyed by the outcome in New York, Hayes persuaded the Criminal Cases Review Commission to refer his case to the Court of Appeal for reconsideration, to consider the New York Court’s interpretation of the LIBOR Definition.
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| ==== The Hayes appeal ====
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| {{drop|T|he Court of}} Appeal considered first a question of legal methodology: whose job was it to determine what the LIBOR Definition meant, and by reference to what?
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| {{Quote|The court was not confining itself, even “principally”, to the language of the [LIBOR Definition] but was taking into account the evidence ... as to how those particular submitters arrived at their submissions in practice. ... This means ... that the question of how the LIBOR Definition was to be construed was being treated as an issue of fact for the jury.}}
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| The Court of Appeal disagreed. Under English law, contractual interpretation is a matter of law, to be resolved by the judge. Evidence of market practice, or the belief of submitters, did not enter into it.
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| The Court of Appeal parsed the LIBOR Definition and interpreted it to mean the ''lowest'' of the submitted rates in the range:
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| {{Quote|In the LIBOR Definition what is required is an assessment of the rate at which the panel bank “could borrow”. ''That must mean the cheapest rate at which it could borrow''. A borrower “can” always borrow at a higher rate than the lowest on offer. But the higher rate would not reflect what the LIBOR benchmark is seeking to achieve, namely identification of the bank’s cost of borrowing in the wholesale cash market at the relevant moment of time. If in a stable and liquid market a submitting bank seeks and receives offers for a reasonable market size at the very time it is to make its submission, and receives offers ranging from 2.50% to 2.53%, it would accept the offer at 2.50%. It would be absurd to suggest that the LIBOR question could then properly be answered by a submission of 2.53%. The bank “could” borrow at that rate in the sense that it was a rate which was available, but that is obviously not what “could” means.}}
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| ====Crimes and contracts====
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| {{Drop|B|ear in mind}} that the “legal question” to be answered here is one of criminal law, not contract. The contract is merely the factual background upon which a crime was allegedly committed. The LIBOR definition, as near as can be approximated, formed part of a contract.
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| Under the intellectual theory of criminal law, ignorance or misunderstanding of the law is no excuse. This is as axiomatic for an effective criminal justice system as “all interests in cash pass by delivery” is to finance. The system would not work were defendants allowed to plead ignorance, even presumptively. ''Ignorantia legis non excusat'', if you are blameless in your inadvertence, is a moral iniquity but still a logical imperative of government.
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| This same imperative does not hold for a contract. Quite the opposite: the whole theory of contract is that the parties ''are'' materially cognisant of the whole thing. That is what [[offer]] and [[acceptance]] requires.
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| So the rules of contractual interpretation have forged a different path:
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| Interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract. [...] ''The background was famously referred to by Lord Wilberforce as the “matrix of fact,” but this phrase is, if anything, an understated description of what the background may include''. Subject to the requirement that it should have been reasonably available to the parties and to the exception to be mentioned next, it includes absolutely anything which would have affected the way in which the language of the document would have been understood by a reasonable man.
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| :—Lord Hoffman in {{cite|Investors Compensation Scheme Ltd|West Bromwich Building Society|1998|1 WLR|896}}}}
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| A couple of observations:
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| One: plainly, what a contract means is, in some way, fact-dependent. It is not, purely, a matter of law. A contract testifies to the parties’ agreement. It cannot be sovereign to it.
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| Another: how ''everyone'' behaved when interacting with the LIBOR Definition helps work out what a reasonable person would have understood it to mean. There is no better indication of reasonableness than direct evidence of the behaviour of fellow [[Man on the Clapham Omnibus|passengers on the Clapham Omnibus]].
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| There is here the odd spectre of the law of [[contract]] forming the backdrop and comprising some of the elements of a criminal allegation. This is rare. Usually, the criminal authorities stay well out of commercial disputes, even where allegations of fraud are flying around — there is a civil tort of fraud — seeing it as a matter of civil loss between merchants perfectly able to look after themselves, and not one requiring the machinery of the state.
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| [[LIBOR]], on whom the mortgage repayments of unwitting retail punters depend, made things a bit different. This is no private matter to be sorted out between gentlemen with revolvers. Nevertheless, still one must apply contractual principles, not criminal ones, to matters of contractual practice.
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| And the argument here is not about economic reality but legal meaning, and legal meaning follows natural, ordinary meaning, and in the world of contractual interpretation, that is viewed from the perspective of the person performing the contract and [[Contra proferentem|against the draftsperson’s interest]], giving the benefit of the doubt to the reader.
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| The same doubt, as it happens, is given to defendants in case of ambiguously framed crimes. For if the LIBOR Definition meant to sanction mandate this “obvious” outcome, it did not do a very good job of it. As a matter of plain English, “could borrow” does not rule out a higher rate, but rather implies it: the Court of Appeal concedes as much, at para 89:
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| {{Quote|The bank “could” borrow at that rate in the sense that it was a rate which was available, but that is obviously not what “could” means.}}
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| The “obviousness” to which the Court appeals here, is not a legal one — show me the authority for that — but one of a certain ''economic'' intuition. If that was the intended legal meaning it would have been really easy to fix it to it was clear.
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| But — per the wording in the LIBOR definition — there is an upper bound to that, delimited by the range of “inter-bank offers in reasonable market size just prior to 1100”. A submitter could not submit a rate higher than any actually offered, any more than it could submit a rate lower than the actually offered range.
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| But to construe “the rate at which it could borrow funds” to mean “the ''lowest'' rate ... ”, involves implying a term into the contract that is not there. It would have been easy enough for the old grandees to have put the matter beyond doubt before knocking the top off that ''Château de Chasselas'', with a single modifying adjective:
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| {{Quote|“An individual BBA LIBOR Contributor Panel Bank will contribute the ''lowest'' rate at which it could borrow funds ...}}
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| But they did not. If they wanted to isolate the risk of a bank talking its own book they could have invited LIBOR banks to submit the minimum rates they were prepared to ''lend'' to each other. They did not do that either.
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| As the system was configured, riven with inherent conflict of interest, there were any number of ways banks could — and for all we can tell now, probably did — skew the data: from whom do you seek bids? How late or early do you seek them? How do you phrase your request?
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| In the absence of clearly drafted prohibitions, given a vaguely articulated common law crime seen as unsatisfactory even by the executive, it seems pretty rich to insist upon a literal reading of a set of rules which didn’t say a lot and to which, on the evidence, no-one paid a great deal of attention. There was a ton of room for flex. We should not be surprised to see people use it to their commercial ends. That is how markets work.
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| ====Everyone was at it====
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| {{drop|A|nd after all}}, ''everyone'' was at it. A fun game, if you have twenty minutes, is to google the names of the {{plainlink|https://en.wikipedia.org/wiki/Libor|LIBOR panel banks}} to see which were ''not'' somehow implicated in so-called “LIBOR rigging”. If you haven’t got twenty minutes, the WSJ’s brilliant interactive {{plainlink|https://graphics.wsj.com/libor-network/|spider network}} will give you the answer in an instant. There were thirty-nine prosecutions for LIBOR manipulation.
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| ''Everyone'' was at it.
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| We must draw one of two conclusions: ''either'' there was a colossal conspiracy by which ''everyone'' was trying to rip off the general public — and failing — ''or this is how everyone understood [[London Inter Bank Offered Rate|LIBOR]] to work''.
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| It might not be edifying, but employees have fiduciary obligations to their shareholders, and if everyone acts according to those fiduciary obligations — or even their own personal self-interests — the selfishness cancels itself out. This is ''exactly'' the logic of Adam Smith’s [[Free market|invisible hand]].
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| ====Conflict of interest====
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| It is not clear what the theory underlying the LIBOR prosecutions was. We can speculate, but none survive close inspection.
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| Is the idea of a merchant prioritising its own commercial interests somehow reprehensible? This will be news to economists, and indeed the commercial courts who have frequently expected merchants to do nothing else.
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| Should LIBOR submitters should avoid conflicts of interest? How ''can'' they? The LIBOR rate is structurally fundamental to the economics of banking. In making LIBOR submissions, all banks had an inherent conflict of interest. Any submission must be at some level, in, counter to or magically neutral to the bank’s intrinsic interest rate exposure. A submission weighted to the lowest available rate structurally favours a bank that is not hedging its interest rate risk: why is that okay?
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| Is the LIBOR rate designed to protect investors, and if so which ones, and why are they special? As noted, classic bank customers would benefit from a higher rate, not a low one. This is of course, all very complicated because banks are very complicated. It is not obvious what is or is not in a bank’s interest.
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| | To an uncomplicated reading, “picking one of the available rates” seems to fall squarely ''within'' the LIBOR Definition. This was a rate at which the bank ''could'' borrow funds. |
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| ====Stare decisis====
| | This is what Hayes did. The complication is that he actively selected the available rate that best suited his or, in some cases, competitors’ derivative trading positions. That is, he was guided by his own commercial interests, and not the “structural” interests of a hypothetical basic bank. |
| {{drop|T|his is a}} real lawyer nerd-out, but in forming its decision the Court of Appeal was confronted with some of its own prior rulings and judgments. The common law [[doctrine of precedent]] means an appeal court is generally bound by its own previous decisions in analogous cases. Usually, these cases are unrelated. But here the prior decisions were “interlocutory” hearings in ''the actual case being appealed'' — certain legal points were “escalated” to the Court of Appeal during the High Court trial.
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| On one hand, it should not make a difference that it is the same case. On the other, that makes a bit of a mockery of the appeal process if the appellate court is bound by the judgment being appealed against, which is what the Court found itself to be here. This should, at least, be a decent justification for a further appeal to the Supreme Court.
| | This is the crux of the case: was this ulterior motive ''dishonest'' in light of the “''proper basis for the submission of those rates''”? The Crown alleged it was. |
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| {{sa}} | | {{sa}} |
| | *[[LIBOR rigging part 2]] |
| | *[[Interest rate swap mis-selling scandal]] |
| *[[Contract]] | | *[[Contract]] |
| *[[LIBOR]] | | *[[LIBOR]] |
| {{ref}} | | {{ref}} |
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Chez Guevara — Dining in style at the Disaster Café™
Extract from the JC’s financial disasters roll of honour
| Scandal |
Date |
Where |
Loss |
Reason |
Firings |
Jail-Time?
|
| LIBOR rigging |
2009 |
Worldwide |
“If your mortgage or car-loan was pinned to Libor then perhaps you were disadvantaged by the manipulation of the rate. But it is also possible that you benefited from it.” To date, no one has been able to prove any loss. |
Bad apples |
Lots of firings of mid-level traders and rate submitters. Strange absence of exits from the Executive Suite, though you could say it contributed to Bob Diamond’s defenestration |
Tom Hayes and Carlo Palombo were among 37 City traders prosecuted for manipulating benchmarks Libor and Euribor. Both men spent time in prison before being released in 2021. Matt Connolly and Gavin Black were convicted in the US then their convictions were overturned in 2023.
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“If the law supposes that,” said Mr. Bumble, squeezing his hat emphatically in both hands, “the law is a ass—a idiot. If that’s the eye of the law, the law is a bachelor; and the worst I wish the law is that his eye may be opened by experience—by experience.”
- — Charles Dickens, Oliver Twist
LIBOR: deep background
Banks have structural interest rate risk
The basic model of a bank is to borrow, short-term, at a low rate, and lend, long-term, at a high rate. Generally, banks calculate interest on deposits, by which they borrow, at a floating rate and on term loans, by which they lend, at fixed rates.
There is a straightforward reason for this: call deposits don’t have a term; they can be withdrawn at any time. All you can do is apply a prevailing daily rate.[1] On the other hand most people borrow for a fixed term and want certainty on how much interest they must pay, so prefer fixed interest.
Since banks borrow in floating and lend in fixed, they have “structural interest rate risk”. It is a natural function of how banks work. They want floating rates to be low, and to move lower. If they don’t manage this risk, things can get funky, fast. Just ask Silicon Valley Bank.
So knowing what that floating rate is, and managing it, is an important risk management function for the bank. A risk well managed is called a “return”. The floating rate is different from the central bank’s base rate, and moves daily in response to market conditions.
Where does this “floating rate” come from, then?
In the good old days, each bank worked out its own floating rates based on its own models, funding costs and market positioning. This process was neither transparent nor standardised. Rates could vary significantly between similar banks. As long as interest rates were not tradable instruments, this did not much matter to banks: they just told their customers what the floating rate was each day, and that was that.
In the early nineteen eighties, some bright sparks at Salomon Brothers figured out how to make interest rates into a tradable instrument. To standardise that instrument, the banks realised they would need a common way of describing how their interest rates change through time. A “benchmark”.
Chess club
Enter the the British Bankers’ Association. This was just the sleepy, city-grandees-in-a-smoke-filled-gentlemen’s-club-in-Threadneedle-Street of your imagination. It began to compile what it called the “London Interbank Offered Rate” — “LIBOR”. This was to be an objective distillation of all the major banks’ borrowing rates.
The method the BBA chose to compile it was simple: it invited 18 major banks to
literally, phone in what they believed they could borrow in various currencies and maturities in the market each day. The BBA would then compile the submissions, “trim” off the top and bottom four, average the rest and publish a set of daily LIBOR rates for each currency and maturity, before toddling off for a liquid lunch at the Garrick and their regular three o’clock tee time at Wentworth.
You get the picture.
With LIBOR published, the banks could then set their rates for call deposits, calculate suitable fixed rates for new term loans, and more importantly trade standardised interest rate instruments by reference to the new LIBOR “benchmark”.
Happy, unadventurous stuff, carried out by happy, unadventurous people. Look: we don’t want to run the interest rate-setting crowd down, but before 2007, the LIBOR rate setting process was like the after-school chess club: snoresville. All the cool kids were out shagging, smoking weed and shorting structured credit. None of the hepcats paid much attention to LIBOR.
Now. It is one of JC’s axioms of financial scandal that calumny happens where you least expect it. This is because success in financial services is in large part about “edge”, and you generally only find an edge where no-one else is looking for it.
The cool kids
Tom Hayes was a cool kid (metaphorically: literally he has been described as “socially awkward”) but he hung out in the chess club. He, and a bunch of other groovers, found some edge there, where no one was looking for it. No one bothered them and they didn’t do a lot of harm — not, at least, that anyone has been since able to point to. But they sent each other lots of embarrassing emails.
In any case, they made an effort to submit LIBOR rates that suited their derivatives trading positions and not, necessarily, their banks’ structural interest rate positions.
That this all came to light as a result of the unrelated “lowballing” scandal, after which lots of people began looking very hard at LIBOR, and not liking what they saw.
Another one of JC’s axioms: if you like sausages, don’t work in a smallgoods factory.
As per the “basic banking model”, to manage its structural interest rate risk, a bank generally would want LIBOR to be low. But deposits are not the only show in town — there are other exposures to the interest rate market: notably, the new tradable instruments: interest rate swaps.
Interest rate swaps
In an interest rate swap, the bank “swaps” interest rates with individual counterparties: it might, for an agreed period, pay one counterparty a fixed rate and receive from it a floating rate; with another it might pay floating and receive fixed.
Before the advent of swaps, the only way of getting exposure to interest rates was by borrowing and lending principal. This required a lot of money down.[2] Interest rate swaps got popular, fast. There are now trillions of dollars in notional interest rate swaps outstanding on any day.
Unlike basic banking, there is no structural bias to swap trading. If a bank swaps a five-year fixed rate for a five-year floating rate, and LIBOR then goes up, by definition the bank profits: the “present value” of its incoming floating rate will increase while the present value of its outgoing fixed rate stays the same. The dealer is therefore “in-the-money”. If it swapped floating for fixed in the same case, it would book a corresponding loss.
While banks try to balance their books so their portfolio of customer swaps offset each other as far as possible, how they “position” the book might help manage the bank’s structural interest rate risk.
Under the “basic banking model”, a bank will always be “axed” for floating rates to be as low as possible. You would expect a basic bank’s LIBOR submissions to reflect that. But a swap trader who is “long” floating rates will wish floating rates to go higher.
This prospect, we venture, was not wildly present in the minds of the Sir Bufton Tuftons who formulated the LIBOR rules that defined how submitting banks should choose the rates they submit each day.
The question arose later, even though it did not arise then: when submitting a rate, what account, if any, may a bank take of its own derivatives trading book?
The LIBOR Definition
The BBA’s guidance came in the form of “Instructions to BBA LIBOR Contributor Banks”. The critical part of these — what the court called the “LIBOR Definition” — ran as follows:
“An individual BBA LIBOR Contributor Panel Bank will contribute the rate at which it could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size just prior to 1100.”
On any day there will be a range of rates at which a bank could borrow. These might be firm offers from other lenders, good faith estimates or model outputs. There is an excellent subjunctive in there, by the way: “were it to do so” implies that that a submitting bank need not actually do so.
Say the range of available rates a bank sees on a given day is between 2.50% and 2.53%. Which of these is “the rate at which it could borrow funds”? You can only choose one.
Setting aside for a moment compliance with the LIBOR Definition, the possible avenues open to a bank in submitting a rate are:
Pick an “available” rate: Choose one of the rates from the range, as above.
Manufacture a blended rate from the range: Contrive some artificial rate from within that range, reflecting a median, a weighted average, or some such thing.
Make one up: Submit a rate that did not fall within the estimated range, whether lower or higher.
“Making one up” plainly falls outside the scope of the LIBOR Definition. “Making a blended rate” does not quite conform to its text, but perhaps captures its spirit.
To an uncomplicated reading, “picking one of the available rates” seems to fall squarely within the LIBOR Definition. This was a rate at which the bank could borrow funds.
This is what Hayes did. The complication is that he actively selected the available rate that best suited his or, in some cases, competitors’ derivative trading positions. That is, he was guided by his own commercial interests, and not the “structural” interests of a hypothetical basic bank.
This is the crux of the case: was this ulterior motive dishonest in light of the “proper basis for the submission of those rates”? The Crown alleged it was.
See also
References
- ↑ You could look at deposits as “rolling overnight term loans”. Their fixed interest therefore resets each day. Yes: there are such things as term deposits, but roughly 70% of deposits are overnight. (see Bank of England statistics).
- ↑ It is a misconception that interest rate swaps do not involve principal borrowing and lending, but that is a story for another day
