They were said to be among the most talented of their generation, recruited after exhaustive interviews and gruelling internships. They worked at firms prepared to spend small fortunes to attract and retain them lest they take their skills elsewhere. Yet the moral bankruptcy of traders implicated in the rigging of the London Interbank Offered Rate (LIBOR), one of the world’s most important interest rates, is matched only by the incompetence with which they covered their tracks.
Take traders at the Royal Bank of Scotland (RBS), who left a trail of evidence in a trove of e-mails and audio recordings detailing how they set about trying to manipulate LIBOR, even after they knew investigators were looking into the issue. “We’re just not allowed to have those conversations over Bloomberg anymore,” said one trader, laughingly, in a call to another who a little earlier had asked in writing for a rigged rate. “Its [sic] just amazing how libor fixing can make you that much money,” was the verdict of another trader.
These exchanges, and many others, were part of a settlement announced on February 6th in which RBS admitted to rigging rates. It agreed to pay fines of $475m to American regulators and another £87.5m ($137m) to Britain’s Financial Services Authority. By the arcane mathematics determining the severity of regulatory fines, RBS is adjudged not to have been as bad an offender as UBS, which last year agreed to pay penalties of $1.5 billion, but is being dealt with a bit more harshly than Barclays, which paid fines of £290m. Regulators said they found attempts to rig LIBOR hundreds of times in at least four and a half years at RBS, compared with the “thousands” alleged in the case of UBS.
But what to do going forward? That's where I come in with Reforming LIBOR: Wheatley versus the Alternatives (January 31, 2013). UCLA School of Law, Law-Econ Research Paper No. 13-02. Available at SSRN: http://ssrn.com/abstract=2209970:
The London Interbank Offered Rate (LIBOR) is the trimmed average interest rate for interbank loans by a panel of leading London banks. LIBOR is the most widely used benchmark rate. An estimated $350 trillion in financial products are based on the LIBOR rate.
In late June 2012, a major scandal broke when Barclays PLC — one of the panel banks whose rates went into calculating LIBOR — agreed to pay $453 million in fines to UK and US regulators to settle allegations that Barclays had attempted to manipulate the LIBOR rate. The probe by multiple national regulators around the world quickly spread to include several other global banks.
In response, the United Kingdom’s Chancellor of the Exchequer charged a commission led by Martin Wheatley with conducting an independent review of the setting and usage of LIBOR. In September 2012, Wheatley released a report proposing a comprehensive 10-point reform plan. In October, the UK Government announced that it accepted “the recommendations of Martin Wheatley’s independent review of LIBOR in full.”
Even though Wheatley’s recommendations likely will have been implemented by the time this article appears in print, they are still deserving of analysis. First, changes and amendments may be necessary to further improve the process, perhaps including some of those suggested in this Article. Second, while LIBOR is one of the most important benchmark rates, it is not the only such rate. Some of these other benchmarks are already under scrutiny. Assessing the merits of various LIBOR reforms therefore may be helpful as regulators evaluate whether these other benchmark rates require similar reform.
In light of LIBOR’s systemic importance as a global interest rate benchmark and the compelling evidence of rate manipulation by panel banks, reforming LIBOR was both a political and economic incentive. This Article explores a number of alternatives that were available to the UK government.
The Article concludes that leaving the problem to market forces had failed and, moreover, was politically unfeasible. Switching to a government-supplied alternative benchmark was both impractical and unwise as a policy matter, as was installing a government agency as a replacement for BBA as the LIBOR administrator. Although vesting the LIBOR administrator with sufficiently strong intellectual property rights to ensure an adequate stream of licensing fees to provide adequate incentives for the administrator and panel banks is an important part of a reform package, but — contrary to what some commentators have suggested — is not viable as a stand-alone reform.
In contrast to the alternatives, the Wheatley Review provides a comprehensive reform package that has proven politically attractive and seems likely to significantly enhance LIBOR’s credibility and attractiveness as a interest rate benchmark. To be sure, the Wheatley regime is not perfect. To the contrary, this Article suggests a number of ways in which it can be expanded and improved. Over all, however, the analysis of the Wheatley Review herein strongly suggests that it will prove a viable starting point as a blueprint for reforming LIBOR and other interest rate benchmarks.