The resignation of Barclays Plc Chief Executive Officer Robert Diamond for the firm’s role in rigging the London interbank offered rate underscores the disconnect between the market’s perception of bank borrowing costs and the benchmark for $360 trillion of global securities.
Barclays has gone from saying in January it can borrow for three months at interest rates that were on average above other banks to saying it can borrow more cheaply than its peers even though the cost of insuring the London-based firm’s debt using credit-default swaps rose 36 percent, according to data compiled by Bloomberg.
The contrast between banks’ daily submissions for Libor and other measures of their creditworthiness shows why regulators from Europe to the U.S. are beginning to fine them for manipulating the market for short-term rates. While the British Bankers’ Association reveals Libor submissions from each bank, the process that the firms use to come up with their individual rates is opaque and not based on actual transactions.
“After the Barclays admission, we have proof that Libor is not a reliable benchmark,” said Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam.
Libor is hardwired into the world’s financial system, meaning credible alternatives have been slow to develop. ICAP Plc, which started the New York Funding Rate in 2008 amid concern about the veracity of Libor, cut the minimum number of participants in April required in its daily survey of unsecured loans because of a decline in interbank lending.
Libor is determined by banks’ daily estimates of how much it would cost them to borrow from one another for different time frames and in different currencies.
Princeton University economist and former Federal Reserve Vice Chairman Alan Blinder said in an interview on Bloomberg Television’s “Market Makers” with Erik Schatzker and Scarlet Fu on July 2 that a “real market” may come from the Libor investigations and that the current system is an “archaic” way to set rates. At least a dozen firms are being probed by regulators worldwide for colluding to rig the rate.
Barclays employees overseeing Libor submissions routinely accommodated requests that benefited traders at their own and other banks, according to the U.S. Commodity Futures Trading Commission. The BBA, which has overseen Libor for 26 years, created a steering group of bankers and regulators in March to consider reforms in light of the probes.
The BBA was aware that banks including Barclays were low-balling their Libor submissions during the financial crisis to avoid the perception they were struggling to borrow cash, according to CFTC documents.
“During periods of financial stress it’s not clear if Libor really represents an interbank offered rate,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.
Diamond, 60, quit July 3 after the U.K.’s second-biggest lender was fined a record $451 million when investigators found traders and senior managers “systematically” tried to rig Libor and Euribor, its euro equivalent. Chief Operating Officer Jerry Del Missier also stepped down, while Marcus Agius, who said this week he planned to resign, will become full-time chairman and lead the search for a new CEO.
Diamond came under increasing pressure from politicians including British Prime Minister David Cameron before his position at the head of Barclays became untenable. Cameron’s deputy, Nick Clegg, openly called for the CEO to go this week.
“The idea that one can base the future calculation of Libor on the idea that ‘my word is my Libor’ is now dead,” Bank of England Governor Mervyn King said at a press conference to present the central bank’s Financial Stability Report in London on June 29. “It will have to be based in the future, in my judgment, on actual transactions in order to bring back credibility to the system.”
John McGuinness, a spokesman for Barclays in London, declined to comment. Brian Mairs, a spokesman for the BBA, didn’t return a phone call seeking comment.
The rate Barclays says it pays for three-month dollar loans diverged from the Libor composite on Feb. 27, after largely tracking it since 1994, BBA data show. The U.K. lender’s rate is now 12 basis points, or 0.12 percentage point, below the benchmark, compared with a 16.8 basis-point gap June 1, the widest since at least 2000.
As the spotlight on Libor intensifies, the rates different banks give to the BBA are diverging, after being virtually identical at the start of 2007 before the worst financial crisis since the Great Depression.
The gap between the highest submission, currently from French lender Societe Generale SA, and the lowest, from HSBC Holdings Plc, has increased to 33.8 basis points. On Jan. 3, 2007, when Libor was at 5.36 percent, the gap between the highest and lowest submissions was just 1 basis point.
Barclays now puts in the second-lowest rate after HSBC, which says it can borrow at 0.26 percent. Credit-default swaps insuring HSBC’s bonds rose 4 percent since Jan. 27 to 123 basis points, according to Bloomberg data. Contracts on Barclays jumped to 209 from 153 during the same period.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.
The CFTC ordered Barclays on June 27 to keep thorough records on how it sets its Libor submissions and to erect Chinese walls between traders and rate-setters. It also said lenders should expect random checks on whether their rates reflect actual borrowing costs.
As part of its settlement, the CFTC ordered Barclays to amend how it sets Libor. Submissions should be based on actual trades if possible. Where no trades have taken place, the rate-setter can consider factors including how much competitors paid to borrow and market conditions, the CFTC said.
Rate-setters should be prohibited from “improper communications” and not work within earshot of derivatives traders, according to the commission. Barclays must keep extensive records on all its Libor submissions, including details on who the rate-setter was and how the figure was derived. The bank must also undergo annual audits and be willing to provide data to regulators on demand.
On Sept. 13, 2006, a senior Barclays trader in New York e-mailed the person who submitted the rate, “Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the lib or fixing at 5.39 for the next few days. It would really help,” according to a CFTC document.
In an exchange on April 7, 2006, a submitter responded to a request for low U.S. dollar Libor submissions from a swaps trader with: “Done ... for you big boy,” the CFTC said.
“It’s the damage to confidence that corporates are concerned about,” said John Grout, the policy and technical director of the Association of Corporate Treasurers in London. The group represents borrowers in the loan market, where interest rates tend to be based on Libor or other interbank rates. “If people don’t trust these things, you can get liquidity reducing, you can get investors starting to add spreads onto corporate borrowing costs, which is not helpful.”
Three members of the new Libor steering committee interviewed by Bloomberg News last month said changes would be incremental because structural modifications in how the rate is calculated could invalidate trillions of dollars of contracts and result in litigation. They ruled out stripping the BBA of its oversight and scrapping the survey system in favor of a rate based entirely on actual trades.
The British government will emphasize to the BBA at the steering group’s next meeting that only drastic changes will suffice, according to a person with knowledge of the matter, who asked not to be identified because the talks are private.
Chancellor of the Exchequer George Osborne, speaking to lawmakers in London yesterday, said the FSA is “committing significant resources” to investigate “systemic failures” over the manipulation of Libor.