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  • Avi Aporve Khanna

THE LIBOR RIGGING SCANDAL AND ITS AFTERMATH

Libor

The LIBOR London inter-bank offered rate is the main standard interest’s rate supporting over $450 trillion worth of deals. Libor is the normal financing cost at which the vast majority of the substantial banks in London could get from alternate banks. Libor is normally ascertained at 11.am after the panel banks submit their estimated borrowing costs. Currently, the rates are computed for 5 different currencies at 7 dissimilar maturities which can be overnight, 1 week, and 1, 2, 3, 6 and 12 months.

“Reasonable market size” is not deliberately measured in terms of quantity. To set LIBOR’s daily rate, there are a number of 11 – 16 designated banks that are required to submit prevailing interest rates that they pay or a near estimate of interest rates that they intended to pay or borrow from their peer banks. Depending on the average of the submitted interest rates, the LIBOR is calculated for the various currencies

Between 2003 and 2012 period Reuters published the LIBOR on bald of the British Bankers Association (BBA) but after 2014 the entire Libor was under the supervision of Intercontinental Exchange Group (ICE) to make sure that there is no manipulation of rates. There was a general assumption that the submitted rates or estimates of rates were accurate and were given in good faith because this was an interbank agreement. Neither was there suspicion that at one time, banks could collude to provide the falsified estimates.

All participating banks were expected to submit their estimate every morning and it is up the estimates that the British Bankers' Association set the average LIBOR that was published by Reuters from all the other banks and financial institutions to peg their interest rates. All the individual contributor panel banks used the rates or borrowing funds based on the LIBOR. The LIBOR also set the rate for borrowing so the contributor panel banks asked or accepted the interbank offer at a reasonable market process before 11:00 am every morning.

Libor as the reference rate

Libor was important because the borrowers and the lenders used to hedge interest rates by linking their debt to the LIBOR. The lenders and borrowers used the Libor as the reference rate. LIBOR was a satisfactory benchmark that helped hem reduce the impact of the interest rates on their values. Almost all banks set interest rates based on the LIBOR. A number of financial institutions and credit agencies use the LIBOR as a reference point for their estimates.

As of April 2018, LIBOR was associated with trillions of dollars’ worth of outstanding contracts that spread across various maturities ranging from the 24 hours to 30 years. All those contracts reference the LIBOR. Currently, the value of all the financial contracts that are linked to LIBOR is estimated at over $300 trillion excluding the consumer loans and the adjustable-rate home mortgages. Secondly, LIBOR is important because it influences the way the rate is determined. For example, the interest rate is calculated and contracted to reflect the lowest borrowing rate among most banks as well as the big financial institutions.

Libor for Hedging inter Exposures

Borrowers and lenders used the references rates more specifically the LIBOR to hedge interest exposure. There are many derivatives that are usually used to hedge the interest rates exposure, for example, the interest rates swaps, the interest rates futures and the forward's rate agreement. All these derivatives rely on reference rates such as the LIBOR.

There are a number of rates that are pegged on the LIBOR and usually unexpressed in terms of LIBOR +X bps, in this case, the bps is the basic point and the X marks the premium that the lender charges the borrowers over and above the LIBOR rate. Therefore, increase or decrease in the base rate eventually affects the contact that is tied to the LIBOR rate as the benchmark.

LIBOR is the most commonly used tool as the floating rates for all interest rates swaps, mortgages, student loans, securities, government & corporate bonds and most of the corporate funding. As a tool for setting the settlement process for interest rates futures contract s, the LIBOR, therefore, helps the companies in hedging their interest rates exposure. There the preferred benchmarks are considered fair by the central banks and financial intuition as they base their expectation and interest rates estimates on the same.

Libor rigging scandal

The LIBOR scandal started when allegedly traders from different banks colluded to influence or manipulate the final average rates. Their collision was that they would submit incorrect rates (higher or lower than the actual rate). Their false estimates lead to an increase in the trade profits for their banks. Barclays. Deutsche Bank, Barclays, Rabobank, Royal Bank of Scotland and UBS plotted to manipulate the interest rates to maximize their profits and the plot could be traced to as far as 2003.

As at the time, the international investigation into the LIBOR started in 2012, a lot of money had been lost as the trust in the global financial system and the same was already eroded. However, there was a spillover as the false estimates perpetrated the financial institution as very stable as compared to their actual level of stability.

Even though interest rate manipulation might have occurred in the past, this was not detected until the Barclays bank’s criminal settlement was notified of the likely fraudulent and collusive acts detected in the rate submission. Because of the rate collusion and manipulation, Martin Wheatley the then CEO of the (FCA) proposed to have a new body should be formed as part of the reforms for LIBOR. Wheatly was the one who recommended a LIBOR reform and oversees the implementation and adoption of the Intercontinental Exchange Group (ICE), which was adopted as the independent administrator for LIBOR in 2014.

Any changes in the LIBOR also affected the rates and payment on a wide range of things including auto loans, student loans, corporate bonds, hedge funds as well as the homes loan as they fluctuated with the fluctuation in LIBOR.

A slight manipulation of the LIBOR results in billions of losses in dollar value. The British bankers association LIBOR came under fire after the invitation. All the colluding traders and banks that submitted the false borrowing rates estimates were fined eventually lead to the transfer of the governance to the ICE benchmark administration.

Rate manipulation affected the integrity of the financial systems: - For example, in the case of LIBOR, two agreements were entreated between April 2004 and December 2006 in a particular case. The royal bank of Scotland (RBS) made funding to the Property Alliance Group Limited (“PAG”), at interest rates payable at 1.25% over and above the LIBOR rate while the other provided for interest only 1% about the prevailing LIBOR rate.

It was also an agreement that the borrower had a duty to ensure that the interest rate hedging instrument is acceptable to banks at a specific level for a predetermined period and for a notional amount acceptable to the bank. The implication of such agreement is that the borrower is under contract to pay the bank the money including the interest rates respective of the fluctuation in the interest rates. The LIBOR rates fluctuated significantly over the three months that the bank was under the agreement and the loan was still active, the borrowing party would have to incur excessive losses.

Determination of LIBOR been modified subsequent to the LIBOR rigging scandal

In view of the exhortation of Mr. Wheatley, the intercontinental exchange group began controlling Libor since 2014 and prescribed constructing rate accommodation with respect to exchange information and forcing statutory directions for organization and accommodation techniques. On April 2, 2013, LIBOR turned into a directed movement under the Financial Services and Markets Act 2000.55. U. K’s. the controller should now affirm people in charge of regulating rate entries, and banks are required to have inflexible tenets with respect to clashes of interest.

In February 2014, BBA was replaced by ICE, which turned into LIBOR's new administrator. Other changes included streamlining LIBOR currencies to 5 and maturity to 7, rather than ten and fifteen, separately, and not distributing/publishing rate entries quickly, from July 2013. Another huge change was the execution of criminal assents for rate manipulation.

The other measure was that the Libor will be regulated by the Financial Conduct Authority (FCA) and be operated and administered by ICE. The LIBOR scandal mostly resulted in a variety of civil suits and to make sure that this type of manipulation doesn’t happen in future they decided to make it criminal offence. The power of FCA was extended to make rules regarding the input of banks in the LIBOR setting process. 16 banks were involved in the panel and the Serious Fraud Office has established to begin an investigation on them with respect to the allegation of the fraud that has occurred. Manipulation of LIBOR is a serious offence owing to the fact that it is the most significant interest rate in the banks.

The existence of the adjustments of the LIBOR implies that transactions carried out with banks involve those who gain and those who lose. When it was lowered, the people had to pay low-interest rates while borrowing huge amounts of money. Intervention on the same is underway and many banks will be expected to avail the actual reports as a way of identifying those that were involved in the given fraud. The suggested strategy for the investigation of the issue in question can be gradual interaction with suspected rather than attacking them abruptly. This will give the SFO the opportunity to learn more about the occurrence of the issue and may possibly lay strategies against the occurrence of the problem in the future.

Claims and damages under Libor scandal

The difficulty aroused in determining the exact victims of the Libor scandal and the answer came when the court saw class actions suits filed by Pensioners (pension fund), Householders associations. Commercial developers and even banks were not a party to Libor scandal. In year 2012, even Federal Deposit Insurance Corporation filed a lawsuit on behalf of 38 banks which went bankrupt in the 2008 crisis claiming their losses on Interest-rate derivative investments. As of 2015 may total global fines amounted to 9 billion USD as a result of Libor manipulation.

There are many types of claims that have been formulated in both the US and the UK. The claims include violation of the antitrust laws, racketeering, breach of laws, substantial damages, breach of contract, torts and criminal liability (Fraud) that govern the free exercise of business and commerce. Libor linked claims have also met a lot of loopholes because no banks ever claimed that Libor rate was accurate as it was because it was based on the average of the rates presented to the British banker association and published by Reuters.

Below are the claims and (in fines) damages that can be claimed by the victims after the LIBOR scandal and the criteria to fulfill depends on the contract and communications with the Banks also.

1. The ‘mezzanine’ duty claim

In the matter of the case of Bailey and another v Barclays Bank plc [2014] EWHC 2882, there was a suggestion that if the claimant could not reach the high hurdle of establishing and determining that the bank actually owed a duty to honest and faithful advice, he might claim a breach of the mezzanine duty. The bank owed the client an advisory duty not to misinform the groups. Because the banks had decided to volunteer information about the interest rates but did not provide the information fully, accurately and properly and in the process mislead the claimant like in the case of Crestsign Ltd v NatWest Bank and RBS [2014] EWHC 3043 (Ch).

Property alliance groups (PAG) also claimed that the RBS owed it a mezzanine duty and the RBS failed to relay the accurate information. Nevertheless, tube mezzanine information duty does not mean that the bank was supposed to provide a comprehensive tutorial. The bank had a duty to explain to the claimant what would be involved in fixing the interest rates as well as the possible consequences.

2. The GRG claims

Based on the provision of the PAG’s facility agreements, the royal bank of Scotland had all the rights to require a valuation of properties owned by the PAG against which it hedges the security. The evaluation fees would be paid by the PAG. PAG argued that the rate must have been based on the implied terms that required the royal bank of Scotland to act reasonably in a way that was commercially acceptable.

PAG also argued that the RBG exercises its rights arbitrarily to the extent of breaching the terms and clearly proved that they did not intend to enter into refinancing exercises. The court of appeal concluded that RBS owed a fiduciary duty and must have been free to act in its best interest because the owed no one duty to balance their interest against those of the PAG. Therefore, the court of appeal judge concluded that the RBS did not act in breach.

3. Implied representations

The court of appeal determined that based on the conduct of the RBS, there is a limited implied representation that the Royal Bank of Scotland (RBS) did not itself manipulate or intended to manipulate the LIBOR by selling GBP LIBOR linked derivatives such as swaps. The court found that on the face value of the claims of GBP LIBOR manipulation had not been completed. Therefore, the concern remained the question of the right test for fraud and reliance in cases involving implied representation based on one party’s assumptions. In order to determine express representations, the court has to consider what a reasonable person would have understood from the agreement or context.

4. Damages for Breach of Implied Contractual Terms

Misrepresentation entitled the claimant to rescind the contract or any damages in lieu. The damages in the context of LIBOR scandal would amount to full compensation for the sums that the claimant had paid to the reliant banks under the SWAP agreement. Claimants

5. Negligent misstatement claim

PAG submitted that RBS failed to furnish them any information respect to the bank’s internal estimation regarding the cost of braking the swaps during their lifetime on a 'worst-case scenario' calculation and also failed to provide any worked instances of possible variations of break cost, if the swaps were terminated. RBS’s also failed to provide PAG with information about “potential break costs” give rise to liability under in tort for negligent misstatement. The failure to give full and appropriate clarification to substitute an existing Swap with another amounts to Misstatement and misrepresentation.

The RBS also acted in breach of additional duty to care to ensure when that they provide a full explanation of financial products as the same exists in Bankers trust international case and was carried on by Crestsign Ltd. Therefore, a claimant can ask damages if they asked banks for explanations of financial products and then banks failed to provide the same.

6. Misrepresentation claim

The claimants can seek monetary damages under the Misrepresentation claim. PAG argued that RBS conducts could be assumed as a misrepresentation because PAG was to enter into the LIBOR referenced swaps based on the misrepresented. Even though the court held that PAG did not rely on the alleged by the time it was entering the swaps representations, but the RBS was not involved in trader manipulation neither had it been involved in the same before. Howsoever the Claimants have the right to file damages under Misrepresentation claims and it totally depends upon the scenario.

Fines considered as Damages which was given to parties which have been discussed through the paper.

Future of LIBOR

Considering the LIBOR scandal and the subsequent loss of confidence on the LIBOR, put an end to LIBOR is the most logical step to take. This decision is in support of the FCA decision and announcement to end the LIBOR. 28 The FCA (Financial ConductsAuthority) is the main financial regulatory body c in the UK charged with regulating the conduct of over 58,000 financial services firms in the UK.

FCA is also a prudential regular for the 24,000 financial service firms and financial markets. In the determination of the harm and the lack of confidence of the public on the benchmark, the London Inter-Bank Offered Rate should be faced out but in phases. As of2017, the final date of LIBOR was scheduled for 2021, as the change would influence a number of new and existing transactions.

Even after the reform, it is clear that the LIBOR is still weak benchmarks with many loopholes that can be exploited by perpetrators to manipulate the market. LIBOR was intended to measure the market for unsecured wholesale term lending to banks and in this, it is clear that it is no longer sufficiently active. The publication of LIBOR would be stopped as the new measure comes into effect the smooth transition is intended to help people ever come the unwanted consequences.

Over the last two years, there has been a lot of discussion on SONIA or the sterling overnight index coverage that is intended to replace LIBOR in the end. One of the key strengths of the SONIA is that it reflects the actual trades in the United Kingdom overnight unsecured lending and borrowing market.33 LIBOR as a measure is not sufficiently active as compared to the SONIA because the overnight unsecured lending and borrowing market is more active as compared to the long-term interbank lending market on which the LIBOR was based.

Currently, SONIA is administered by the bank of England and has been undergoing reform to make it's suitable for wide-scale adoption. SONIA’s adoption is driven by the fact that its rates are ruled by the sterling risk-free references set that the banks of England set every time. On the hand, there have been proposals that SONIA would not be effective in isolation and should be combined with a separate bank credit risk measure. As per the recent statement by the bank of England on their webpage they mentioned that “We are the administrator for SONIA. That means we take responsibility for its governance and publication every London business day”.

Finally, the Loan Market Association (LMA) has proposed the Risk-Free Rate (RFR) as a replacement for LIBOR but the RFR is still under development and might take longer than the scheduled 2021 date for complete phasing out of the LIBOR.




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