Andrew Bailey on the Death of LIBOR

The ailing LIBOR benchmark, underpinning $500-$800 trillion worth of financial contracts, has been in a state of malaise for many years. Despite the efforts of regulators to revive the sick scandal-ridden benchmark, which suffered from a series of problems related to cheating and misreporting, it is unsurprising that its slow death will finally come in about four years’ time. As the Chief Executive of the FCA Andrew Bailey recently explained the funeral is set for 2021. But some clearly want LIBOR to live longer. Bailey called LIBOR “a public good” but questioned its current usefulness. Among other things, LIBOR related misconduct resulted in civil claims and fines of £9 billion. And, of course, in the criminal context it resulted in “clustered criminality” of which convicted LIBOR rigger Tom Hayes is a prime example. Clustered criminality, which only reflects a very small part of the ills affecting financial services, is when there “is at least strong suspicion that a crime has been committed and although the culprits may not be immediately clear it seems likely that more than one person was involved.” A succinct account of bankers lying, cheating and colluding to rig LIBOR is found in The Fix where Liam Vaughan and Gavin Finch expose the ills gripping the financial world. Hayes, who operated as “Tommy Chocolate” in the midst of the financial crisis, worked in a culture where “your performance metric” is all about “the edge” and making “a bit more money” because that is “how you are judged”.

In The Spider Network, David Enrich tells the “wild story” of Hayes – who he dubs “a maths genius” – and the backstabbing banking mafia which operated a thoroughly crooked financial system. Breaking the silence in an exclusive interview with The Sunday Times, Hayes’s wife Sarah Tighe vowed to “never stop fighting for my autistic husband, the LIBOR fall guy”. Hayes, who achieved notoriety by miraculously dodging extradition to the US, was jailed for 14 years for fraud but his sentence was reduced to 11 years. Tighe is fighting for her husband’s release and said that she “went apeshit” when officials tried to seize her assets as well. Her morale will undoubtedly be strengthened by the news that former Rabobank traders Anthony Allen and Anthony Conti, who are both British and were convicted at first instance for rigging LIBOR, have had their convictions overturned by the US Court of Appeals for the Second Circuit in New York which found that constitutional rights against self-incrimination had been breached. Tom and Sarah will probably also find solace in the fact that the cycle of cheating was so extreme that even the Bank of England is now implicated in LIBOR manipulation.

They may even find it quite amusing that the SFO has finally decided to go after some big fish by charging Barclays Plc, John Varley, Roger Jenkins, Thomas Kalaris and Richard Boath with conspiracy to commit fraud and the provision of unlawful financial assistance contrary to the Companies Act 1985. The charges arise out of Barclays Plc’s capital raising arrangements with Qatar Holding LLC and Challenger Universal Ltd, which took place in 2008, and a US$3 billion loan facility made available to Qatar, an international pariah state according to Egypt, UAE, Saudi Arabia and Bahrain.

Their hopes will also be boosted by the Serious Fraud Office’s failure to secure convictions in the cases of Colin Goodman, Danny Wilkinson, Terry Farr, James Gilmour, Noel Cryan and Darrell Read. The men called their trial a “sham”. The SFO alleged that the six men conspired with Hayes to defraud because they agreed, upon instruction by Hayes, to influence the submissions of panel banks in the Yen LIBOR setting process. Enrich explains that Cryan had “qualms” about Hayes’s personality but “respected his skills as a trader, albeit a relatively green one.” Cryan found Hayes to be “very, very intense” but was impressed with his ability to grasp market phenomena and trading patterns.

During the financial crisis, the BoE habitually put pressure on commercial banks to deflate their LIBORs. As evidenced in a recording from 2008, a senior manager in Barclays, namely Mark Dearlove, ordered LIBOR submitter Peter Johnson, to lower his LIBOR rates and said:

The bottom line is you’re going to absolutely hate this … but we’ve had some very serious pressure from the UK government and the Bank of England about pushing our LIBORs lower.

Johnson disagreed at first because this entailed violating the rules for setting LIBOR about submitting rates based only on the cost of borrowing cash. But caving in he said “so I’ll push them below a realistic level of where I think I can get money?” to which Dearlove replied:

The fact of the matter is we’ve got the Bank of England, all sorts of people involved in the whole thing … I am as reluctant as you are … these guys have just turned around and said just do it.

Dearlove, who is the head of Barlcays Japan, has been investigated by the SFO on whether Barclays low-balled LIBOR to give a false impression about its creditworthiness.

Chris Philp MP, who is a member of the Treasury select committee, remarked:

It sounds to me like those people giving evidence, particularly Bob Diamond and Paul Tucker were misleading parliament, that is a contempt of parliament, it’s a very serious matter and I think we need to urgently summon those individuals back before parliament to explain why it is they appear to have misled MPs. It’s extremely serious.

Diamond denies misleading parliament. He stands by everything he said previously. Johnson, the Barclays LIBOR submitter, was jailed last summer after pleading guilty to accepting trader requests to manipulate US Dollar LIBOR and Jay Merchant, Alex Pabon and Jonathan Mathew were found guilty of conspiracy to defraud.

Jonathan Mathew, also formerly employed by Barclays, said in his defence at trial that he was abused at work. He contended he was only doing what the senior LIBOR submitter Peter Johnson had taught him to do. Mathew claims he was called a “deaf git” and “bick drain” and says his boss also abused him by “whacking” him at the back of the head with a foot long baseball bat. But the defence betrayed Mathew as it had done Hayes. He could not be presumed innocent on the basis of ignorance. Along with Mathew, Jay Merchant and Alex Pabon were found guilty of conspiracy to defraud whereas Peter Johnson had already pleaded guilty. Mathew has also taken his case to the CCRC and Merchant is reportedly preparing to do the same. Pabon is awaiting a decision in the Court of Appeal regarding his application to appeal his conviction. His wife Julie has said: “We will continue to do everything in our power to ensure Alex’s fraudulent conviction is overturned.”

Sentences passed on them were considerably lenient compared to the 14 years initially given to Hayes. Mathew and Johnson were sentenced to 4 years each, Merchant said manipulation was “completely open” and “we were just doing our job”. He received 6½ years and his junior Pabon got 2¾ years. Evidence from the trial shows that the plotters’ dishonesty was blatantly deliberate because they abused their position of trust and conspired to create skewed US Dollar LIBOR submissions to favour their own derivative positions. But there has been no admission of criminal liability from Barclays, which reacted by purging senior staff in 2012 when the scandal broke. A retrial was sought in the cases of Stylianos Contogoulas and Ryan Michael Reich because a jury failed to reach verdicts in their cases. But both men were subsequently acquitted in April 2017. Notably, against that, white collar crime has been rising and prosecutions have hit a six-year low: there were 9,489 prosecutions in 2015 in comparison to 8,304 last year.

The US government has also filed a $400bn LIBOR rigging claim in the High Court in London on behalf of 39 banks that were rescued during the financial crisis. The Federal Deposit Insurance Corporation alleges banks including Barclays, Lloyds Banking Group and Royal Bank of Scotland manipulated LIBOR rates to keep them artificially low and their actions contributed to the failure of numerous US banks during the financial crisis. The claim contends that nine lenders worked in tandem with the British Bankers’ Association (BBA) to coordinate the sustained and material suppression of LIBOR between August 2007 and at least the end of 2009. Both lenders and the BBA are facing fresh accusations of knowingly doing business with rates skewed in their favour.

LIBOR was famously “reset” by the Wheatley Review amid much fanfare and the markets were reassured that any rigging related issues would become a thing of the past with a new and rejuvenated system of control and oversight. But five years after record fines were imposed and parliamentarians and the public were outraged by the arrogant and cocky behaviour of the likes of Bob Diamond, we are being informed that it will take yet another four years to phase LIBOR out entirely. Andrew Bailey’s speech at Bloomberg London (27 July 2017) on LIBOR’s future explained that the benchmark will be sustained until the end of 2021 in order to facilitate a smooth/planned transition.

Bailey said that work must be initiated on planning a system for transitioning to purely transaction based alternative reference rates. He explained that despite the improvements made over the past four years the absence of active underlying markets throws up a serious question about the sustainability of the LIBOR benchmarks that are based upon these markets. In the past, Bailey has highlighted the importance of regulating the “very big landscape” of financial services. Now he is stressing that nothing can be “taken for granted” anymore. He did not dwell on the scandalous aspects of LIBOR but he did question its sustainability. For those that rely on the benchmark, his emphasis was to produce a “better model” based on transactions, not on judgements.

He applauded the achievements of the ICE Benchmark Administration (IBA) and the twenty panel banks and said they “introduced a step change in the quality of governance around submissions to this important reference rate.” Bailey pointed out that, pursuant to the Senior Managers Regime, every submitting bank must have a senior executive responsible for benchmark contributions. However, governance improvements are appropriate and for Bailey:

The absence of active underlying markets raises a serious question about the sustainability of the LIBOR benchmarks that are based upon these markets. If an active market does not exist, how can even the best run benchmark measure it?

After all that has been, panel banks are uncomfortable about providing judgement based submissions without large-scale actual borrowing activity against which to validate those judgements. Without an active market even the best run benchmark cannot measure it.

Alternative benchmarks have been identified to wean the world off LIBOR. In the UK the Risk Free Rate Working Group selected reformed SONIA as its proposed alternative benchmark. In the US, the Alternative Reference Rates Committee chose a broad Treasuries repo rate. Unlike LIBOR, both these benchmarks have the advantage of being anchored in active markets and neither involves expert judgement. Issues of the membership of the panel banks fall away because transaction data are collected from all relevant market participants by the relevant central banks. Similarly, benchmarks such as EONIA, SARON and TONAR also benefit from being anchored in overnight markets.

Bailey preferred a slow transition to a short, uncertain and disruptive process. This would make it easier to iron out any legacy issues. He said rushing things could trigger further uncertainty and to mitigate risk he advocates a controlled transition and he noted that since panel banks use LIBOR for their own businesses they realise their transition costs and risks. The four-five year period in contemplation is longer than the period under European Benchmarks Regulation (EU) 2016/1011 which gives regulators the power to compel banks to contribute to LIBOR where necessary. The onus is on market participants to take responsibility for their individual transition plans.

Regulators will help to streamline and coordinate the process but after the end of the four-five year period, the FCA will no longer persuade, or compel, banks to submit to LIBOR and it would become unnecessary for it to sustain LIBOR through its influence or legal powers. However, as noted at the outset, not everyone agrees with this analysis and Jason Williams, a strategist with Citi Research has warned that: “US dollar LIBOR has to live longer, because the replacement is going to take a while to roll out”. Moving the trillions of dollars of transactions pegged to LIBOR is likely to take longer than the rigid timeline proposed by Bailey.

Indeed, key questions arise in relation to whether any LIBOR banks will be willing to contribute to the benchmark after the proposed timeline of 2021 and if so then for how long. Therefore, the death of LIBOR is not seen as a done deal for the markets.