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LIBOR rigging: Difference between revisions
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{{a|casenote|{{image|Dramatic look|jpg|''[[Dramatic look gopher]] goes to the [[British Bankers’ Association]]'' {{vsr|2024}}}}}}{{quote| | {{a|casenote|{{image|Dramatic look|jpg|''[[Dramatic look gopher]] goes to the [[British Bankers’ Association]]'' {{vsr|2024}}}}}}{{quote| | ||
{{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.” | |||
{{drop|“I|f the law}} supposes that,” said Mr. Bumble, | |||
:— Charles Dickens, ''Oliver Twist''}} | :— Charles Dickens, ''Oliver Twist''}} | ||
== LIBOR: deep background == | |||
==== Banks have structural interest rate risk ==== | ==== Banks have structural interest rate risk ==== | ||
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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”. | 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”. | ||
==== Chess club | ==== Chess club ==== | ||
{{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. | {{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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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. | 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. | ||
==== 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]]. | |||
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'']]. | ||
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. | |||
==== 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. | |||
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. | |||
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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====“A conspiracy to defraud”==== | ====“A conspiracy to defraud”==== | ||
{{drop|H|ayes was indicted}} on the ancient [[common law]] offence of “conspiracy to defraud”. Criminal law minutiae, perhaps, but he was not charged under the | {{drop|H|ayes was indicted}} on the ancient [[common law]] offence of “conspiracy to defraud”. Criminal law minutiae, perhaps, but he was not charged 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> | ||
In enacting the Fraud Act 2006, the government did not follow the Law Commission’s recommendation but “decided to retain [''common law conspiracy to defraud''] for the meantime, but accepted the case for considering repeal in the longer term.” <ref>Ibid.</ref> | |||
In any case, common law conspiracy to defraud was not abolished, still hasn’t been, and that is what Hayes was charged with. | In any case, common law conspiracy to defraud was not abolished, still hasn’t been, and that is what Hayes was charged with. | ||
Being a common law offence, its ingredients are not sharply delineated — this in itself is 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> — | Being a common law offence, its ingredients are not sharply delineated — this in itself is 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> — though it seems to be along the following lines: ''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> | ||
The crux: was Hayes ''dishonest'' when he submitted his LIBOR rates? | The crux: was Hayes ''dishonest'' when he submitted his LIBOR rates? | ||
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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.”}} | :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.”}} | ||
The jury answered, “yes” to all three questions and Hayes was sent to prison for 14 years. | The jury answered, “yes” to all three questions and Hayes was sent to prison for 14 years.<ref>Reduced on appeal to 11. He is out now.</ref> | ||
He was not the only one. In total, thirty-seven traders were prosecuted in London and New York for interest rate benchmark manipulation. Of these, nineteen were convicted and nine imprisoned. | He was not the only one. In total, ''thirty-seven'' traders were prosecuted in London and New York for interest rate benchmark manipulation. Of these, nineteen were convicted and nine imprisoned. | ||
====Meanwhile, in Gotham City==== | ====Meanwhile, in Gotham City==== | ||
{{Drop|T|he travails of}} other LIBOR submitters is interesting purely because of its scale — we’ll come to that — but also because two men convicted for manipulating LIBOR in the United States in similar circumstances successfully appealed. Their appeal focused on ''what the LIBOR Definition actually meant''. | {{Drop|T|he travails of}} other LIBOR submitters is interesting purely because of its scale — we’ll come to that — but also because two men convicted for manipulating LIBOR in the United States in similar circumstances successfully appealed their convictions in 2022. Their appeal focused on ''what the LIBOR Definition actually meant''. | ||
In {{casenote|United States|Connolly and Black}}<ref>{{citer|United States|Connolly and Black|2d Cir. 2022|No. 19-3806|}}</ref> the United States Court of Appeals for the Second Circuit found the meaning of the LIBOR Definition to be a question of ''fact'': filtered through the prisms of grammar, usage, subject matter expert opinion and industry practice. | In {{casenote|United States|Connolly and Black}}<ref>{{citer|United States|Connolly and Black|2d Cir. 2022|No. 19-3806|}}</ref> the United States Court of Appeals for the Second Circuit found the meaning of the LIBOR Definition to be a question of ''fact'': filtered through the prisms of grammar, usage, subject matter expert opinion and industry practice. | ||
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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''.}} | 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''.}} | ||
This led the US court to conclude that picking from a range of available rates, however the end choice was motivated, could not be fraudulent. It was within the rules. Connolly and Black were acquitted. | This led the US court to conclude that picking from a range of available rates, however the end choice was motivated, could not be fraudulent. | ||
{{Quote|“Here, the government failed to show that trader-induced LIBOR submissions did not reflect rates at which DB could have borrowed. If the submissions did reflect rates at which DB could have borrowed, they complied with the BBA LIBOR Instruction, and the LIBOR submissions were not false.”}} | |||
It was within the rules. Connolly and Black were acquitted. | |||
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. | 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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{{Quote|“The bank “could” borrow at that [''higher''] rate in the sense that it was a rate which was available, but that is obviously not what “could” means.”}} | {{Quote|“The bank “could” borrow at that [''higher''] rate in the sense that it was a rate which was available, but that is obviously not what “could” means.”}} | ||
The “obviousness” to which the Court appeals here is not a legal one — | The “obviousness” to which the Court appeals here is not a legal one — there is no authority for that proposition at all — but the Court’s ''economic'' intuition based upon an abstract conceptualisation of “borrowing”. | ||
But borrowing does not happen in the abstract. | |||
Per the plain words of the LIBOR Definition there is an upper bound 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 one actually offered. | Per the plain words of the LIBOR Definition there is an upper bound 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 one actually offered. | ||
So, to construe “the rate at which it could borrow funds” to mean “the ''lowest'' rate ... ”, one must imply a term into the contract that is not there. Courts do not do this lightly. In Mackinnon LJ’s memorable words:<ref>''[[Shirlaw v Southern Foundries&action=edit&redlink=1|Shirlaw v Southern Foundries]]'' [1939] 2 KB 206</ref> | So, to construe “the rate at which it could borrow funds” to mean “the ''lowest'' rate ... ”, one must [[Implied term|imply]] a term into the contract that is not there. Courts do not do this lightly. In Mackinnon LJ’s memorable words:<ref>''[[Shirlaw v Southern Foundries&action=edit&redlink=1|Shirlaw v Southern Foundries]]'' [1939] 2 KB 206</ref> | ||
{{Quote|“That which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common ‘Oh, of course!’”}} | {{Quote|“That which in any contract is left to be implied and need not be expressed is something so obvious that it goes without saying; so that, if, while the parties were making their bargain, an officious bystander were to suggest some express provision for it in their agreement, they would testily suppress him with a common ‘Oh, of course!’”}} | ||