UBS AG’s (UBSN) decision to become first- confessor as regulators probe the alleged manipulation of interest rates will ratchet up the risks for other banks that set the benchmark for $360 trillion of securities worldwide.
The bank is seeking to insulate itself from the biggest possible fines from the investigation by turning itself in to regulators before its competitors to gain leniency, lawyers said. The plan still leaves the Zurich-based lender vulnerable to lawsuits from clients and raises the potential antitrust penalties for its competitors.
“It’s a sound tactic and well-trodden path,” said Steven Francis, a regulatory lawyer at Reynolds Porter Chamberlain in London. “With competition law, there is a very well-recognized system of giving first-mover advantage to any cartel member who blows the whistle on the others.”
UBS, already facing scrutiny of its internal controls after posting a $2.3 billion loss from unauthorized trading last year, is trying to shorten the probe against itself by cooperating. Its disclosure to regulators that employees colluded to rig the London interbank offered rate is likely to renew calls for regulators to overhaul the way firms set the rate.
“This is a quaint, insider club which is clearly not fit for the 21st century,” said Richard Werner, a finance professor at the University of Southampton, England. “There is no independent verification of the interest rates reported by the banks, which is a big problem. This affects the whole economy: mortgages, derivatives contracts across the world.”
By making the first disclosure to regulators, the Zurich- based lender will make it harder for competitors including JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) to claim similar protection. UBS’s competitors could face higher penalties for not coming forward earlier, Francis said.
The damages, if the probes establish liability, “could be enormous, depending on how they’re defined,” said Peter Henning, a law professor at Wayne State University in Detroit. “It will be a mess evaluating damages, given all the derivatives contracts and swaps tied to these rates. This won’t be resolved anytime soon.”
Libor is derived from a survey of banks conducted daily for the British Bankers’ Association in London. The lenders are asked how much it would cost them to borrow from one another for 15 different periods, from overnight to one year, in currencies including dollars, euros, yen and Swiss francs. After a predetermined number of quotes are excluded, those left are averaged and published for each currency by the BBA before noon.
Based on UBS’s disclosures, regulators in Canada have alleged that banks communicated with each other and through brokers to manipulate the Yen Libor rate.
Lenders aren’t supposed to know each other’s submissions until the rates are released, the Canadian Competition Bureau said in court filings last year. By doing so, the traders affected all interest-rate derivatives that use yen Libor as the basis for their price. In an interest-rate swap, banks make or lose money depending on the floating interest rate, usually tied to Libor, the bureau said.
“Libor has always been a lie, because it represents what banks would pay for funds rather than what they are actually paying,” said Peter Hahn, a finance professor at London’s Cass Business School and a former managing director at Citigroup. “People who have an incentive to make money from mispriced markets are able to misprice those markets, and that is a serious control problem.”
The BBA is “committed to retaining the reputation and integrity of BBA Libor,” the London-based lobby group said in a statement. “It is fully transparent. All of the data inputted by the contributor banks is publicly available, as is our methodology.”
UBS disclosed in a July filing it had got conditional immunity from the U.S. Department of Justice in its probe of Libor. In February, it said it had received similar immunity from the Swiss Competition Commission. Spokesman Richard Morton declined to comment on the lender’s leniency agreements.
The Department of Justice operates a first-in-the-door policy, leaving other banks unable to claim the same protection. The leniency deal limits civil claims to actual damages rather than triple damages, UBS said in its filings. It doesn’t stop other regulators, such as the Securities & Exchange Commission and the Commodity Futures Trading Commission, from filing suits.
Even though other agencies can still sue UBS, the agreement with the Department of Justice “gives them some leverage with other parts of the government,” Henning said. The DOJ also “gives credit to whoever is second to come forward. You can still get benefits but it becomes more discretionary. The others are essentially competing to show they’re cooperating the most. That the probe has expanded is a sign of active cooperation.”
Meanwhile, investors have already filed suits against banks alleging they manipulated Libor in violation of U.S. antitrust law. Charles Schwab Corp. (SCHW), the largest independent brokerage by client assets, sued Bank of America Corp., Citigroup Inc. and other banks in August, claiming they manipulated Libor from 2007 in violation of U.S. antitrust law.
UBS has also sought immunity from prosecution by Canadian regulators, three people with knowledge of the inquiry said last week. Canada’s Competition Bureau only offers immunity to the first party to alert it to antitrust violations.
‘First In Marker’
The lender, which wasn’t identified in the Competition Bureau’s lawsuit, was granted a “first in marker” on Jan. 5, 2010, confirmation that it was the first to request immunity and a guarantee of its place at the front of the queue, according to court documents filed in the Ontario Superior Court in May.
Over a series of five meetings in April and three in May, lawyers for UBS gave information to the regulator, including details of the lender’s own internal probe, the filings show. Based on the lender’s disclosures, the regulator said HSBC Holdings Plc (HSBA), Royal Bank of Scotland Group Plc (RBS), Deutsche Bank AG (DBK), JPMorgan, Citigroup, as well as brokers ICAP Plc and RP Martin Holdings Ltd. colluded to manipulate the Yen Libor rate, according to the court papers. Not all attempts were successful.
The European Union, which raided UBS in October as part of its own investigation, hasn’t said it if it will grant immunity. The EU typically doesn’t publicly disclose which company is granted immunity until it levies fines in a case.
Since 2002, the EU has waived fines for the first company to come clean in a price-fixing cartel. The maximum fine for members of a cartel under European rules is 10 percent of sales.
European regulators have fined banks before: the European Commission, the EU’s antitrust regulator, fined eight Austrian banks a total of 124.3 million euros in 2002 for colluding in the so-called Lombard Club to fix fees and set interest rates for savings and loan products.
Britain’s Financial Services Authority is investigating “significant cross-border allegations in regards to Libor,” according to Tracey McDermott, the regulator’s acting head of enforcement. She publicly disclosed the probe for the first time in a speech in London today.
UBS is cooperating with the FSA’s probe and is likely to receive the standard 30 percent discount on any financial penalty for early settlement, said a person with knowledge of the probe, who declined to be identified because the decision hasn’t been made public.
“If you’re the first mover, there is a real chance that the FSA will use its discretion to make the fine lower,” Francis said. “With the Libor case, it’s clearly so high- profile, you’ve got no chance of escaping a penalty, but every chance of it being on the lower end of the range.”
So far, only Japanese regulators have punished the lender over the interest-rate probe. In December, Japan’s Financial Services Agency ordered the UBS Securities Japan division to suspend trading in derivatives transactions related to Yen Libor and Euroyen Tibor from Jan. 10 to 16. The regulator found that the securities unit had “serious problems” in its internal controls and ordered it to develop a new compliance program.