Should Libor-Rigging be treated like Price Fixing?

(by Andreas Stephan) With multi-million pound fines, high profile resignations, heated arguments in Parliament and calls for criminalisation by the UK government, one would be forgiven for thinking that Libor rigging is worse than price fixing. Few fully understand the practice of falsely reporting expected borrowing rates, but everyone seems to want it severely punished. The scandal first came to light in 2008 when traders realised  the Libor rate was no longer reflecting reality. The question is whether calls for punishment and criminalisation are the best way to deal with Libor-fixing or whether the case has simply become a vent for wider public anger at the perceived evils of the banking sector.

The London Interbank Offered Rate (Libor) is an average interest rate based on what 18 leading banks estimate their cost of borrowing from other banks to be. Along with its European equivalent (Euribor), it is considered a very important benchmark for calculating interest rates worldwide. The banks report these rates on a daily basis to Thomson Reuters who then publish the Libor rate. On 27 June the Financial Services Authority (FSA) fined Barclays £59.5 million for misconduct relating to Libor and is investigating a number of other banks for similar practices. The FSA highlighted failings by Barclays management, noting that internal compliance had not addressed the misconduct effectively, despite Libor issues being escalated to Barclays compliance management on three occasions in 2007 and 2008. The case has resulted in three top Barclays executives resigning. Parliament has been arguing over how best to respond to the scandal and the government has even called for Libor-rigging to become a criminal offence. This has been supported by the opposition leader, who has called for a new financial crime unit to be set up within the Serious Fraud Office.

Peculiarly, the practice is not explicitly prohibited in UK law. As highlighted in a Parliamentary document published on 3 July, the FSA fine was imposed under the general discretion they enjoy under the Financial Services and Markets Act 2000. The fine was for breach of principle 5 of the FSA Handbook which states that, ‘A firm must observe proper standards of market conduct’. Libor-rigging does not appear to fall within the FSA’s market abuse criminal powers, which cover actions ‘in relation to qualifying investments traded on a market’. So instead, the Serious Fraud Office has decided to launch a criminal investigation into the individuals involved under s.1 Fraud Act 2006. This requires the individuals to have dishonestly (yes it rears its ugly head again!) made a false representation, and intended through it to make a gain or cause a loss. There is no requirement of an actual gain or loss. Although antitrust lawsuits have been launched in the US alleging collusion, Libor-rigging is more akin to a fraud than a cartel, which generally involves an agreement to manipulate the price or supply of a product of service. Libor is more an index for confidence in the banking market. The FBI has launched its own criminal investigation in the US, and the EU Commissioner overseeing financial services has  announced that he will amend EU market abuse rules so that Libor-rigging can be punished more easily.

While there has been a very public and widespread call for blood (including media calls for prison sentences), there is little understanding of what Libor-rigging is or what harm has actually been caused. The banks are alleged to have reported artificially high rates before the crisis in order to help trading desks dealing in bond markets, and artificially low rates during the crisis in order to make their positions seem healthier than was really the case. This would have had a direct impact on mortgages and loans whose interest rates are influenced by Libor. During the crisis, the under-reporting may actually have benefited some borrowers and may have helped boost short term confidence in the banking sector – something which is of paramount importance to the availability of credit in the wider economy. Some have suggested that Libor-rigging hid the true extent of the banking crisis, causing the eventual bank bailouts to be more significant than might otherwise have been the case – although Barclays did not require a bailout themselves.

Although Libor-rigging clearly has the potential to cause a lot of harm, calls for a punitive approach similar to that taken against cartels may distract from the need for structural and regulatory reforms.  First, there seems to be something fundamentally wrong with the way in which Libor operates. It is made up of borrowing rate estimates from leading banks which must be given even if the bank has not actually borrowed any money on that day. These figures are then published for all the other big banks to see and are taken collectively as an indicator of how healthy those banks are individually and as a group. In this setting, some level of manipulation and tacit collusion seem inevitable, as there is no real competitive dynamic to restrain the bank’s behaviour. Second, we know who the prospective culprits are in Libor-rigging. Cartel enforcement is a utilitarian form of extreme regulatory control. The use of deterrent sanctions and leniency are a justifiable necessity because we do not know exactly where price fixing or bid-rigging might occur. By contrast, Libor concerns only a small identified group of banks operating in a regulated industry. This makes a regulatory rather than a punitive approach more appropriate.

The strong call for blood we have seen reflects wider anger at the perceived failings of the banking industry and a growing belief that responsibility for the economic downturn should mainly lie with ‘greedy bankers’. Politicians have been happy to passively allow this perception to gain strength as it deflects away from their own historical failings in regulating the economy.

2 Responses to Should Libor-Rigging be treated like Price Fixing?

  1. Professor Alan Riley says:

    Dear Andreas, I do disagree with you on this…and so I suspect does the DOJ…as I say in my Respublica piece…UBS has been accepted into the leniency programme with conditional immunity..it is almost inconceivable that Sherman Act prosecutions will not follow.
    Regards
    Alan
    See link here http://www.respublica.org.uk/item/The-Feds-in-the-City-

  2. Further discussion on the Competition Law implications of libor rigging by Arianna Andreangeli: http://www.law.ed.ac.uk/clie/blogentry.aspx?blogentryref=8983

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