With the start of the trial of former Barclays traders last week, the criminal justice phase of Libor reckoning is now in full swing.
When I last wrote about Libor two years ago, the focus was on the market conduct of banks and other financial intermediaries. Since then, Libor fines reached $9.1 billion, while regulatory settlements for foreign exchange rigging have cost banks over $10 billion (see chart).
It may seem like a logical progression to move from the conduct of banks to the crimes of individuals, but the Barclays trial has already highlighted tensions and contradictions between the two approaches. Some obvious questions deserve to be asked, such as, why have 27 people been charged for interest rate benchmark rigging but none for FX rigging? Why aren’t more senior people getting charged?
We’ll look at these questions in turn but let’s start with the tensions between market conduct and criminal prosecution. Remember that Libor is set according to a process: people in a bank called submitters are supposed to estimate what their bank would need to pay to borrow from other banks. The extreme estimates are taken out and those remaining are averaged together and published as Libor.
Allowing that process to be corrupted and subverted for profit is what opened banks to regulatory action for misconduct, and enables individuals within banks to be prosecuted for fraud.
That’s how the Tom Hayes trial happened. The former UBS and Citigroup trader emerged early on as a nexus of Libor rigging when the US Department of Justice indicted him in December 2012. Shortly after that Hayes began cooperating with the UK’s Serious Fraud Office. This may have saved him from US clutches but it torpedoed his UK defence because he admitted being knowingly dishonest when he rigged Libor.
Of course, Hayes made this admission as part of what he thought would be a plea bargain arrangement with the SFO, one that subsequently broke down, providing prosecutors with a slam-dunk argument for the jury. But the limits of that strategy became apparent in the subsequent broker trial.
The SFO had evidence that brokers at the firms ICAP and RP Martin were used by traders such as Hayes to influence Libor submitters under the pretext of providing ‘market colour’. However, this was not part of the formal Libor submission process and the brokers successfully persuaded the jury that their role was inconsequential, and walked free.
This gives us a clue as to why the SFO decided last month not to prosecute any FX traders. Superficially, interest rate benchmarks and FX sound similar, with their language of ‘fixings’ at specified times of the day. But in reality they are very different. People familiar with the investigation point out that FX fixings are not a formally separate process from trading like a Libor fixing. Instead, they are more of a service or product offered to wholesale customers by traders themselves. It may be poor control by banks that allowed rigging of FX fixings to flourish – hence the fines – but it wasn’t necessarily fraud by individuals whose trading business was conflicted by managing the products.
While the current Barclays Libor trial still has weeks to run, a similar tension has emerged here too. The issue is that banks themselves subverted the Libor submission process by collapsing interest rate derivative trading and benchmark setting into the same business, thus creating a situation similar to FX.
No bank better encapsulates this than Royal Bank of Scotland. The Financial Conduct Authority’s February 2013 final notice to RBS sums it up:
‘In October 2006, RBS established a business model that sat Derivatives Traders in close proximity to Primary Submitters and encouraged the two groups to communicate without restriction. This created an obvious risk that Derivatives Traders would seek improperly to influence Primary Submitters’.
In such circumstances, it is hard to accuse junior traders of being dishonest, because they had been institutionally set up to rig Libor by management. As a justification, banks could say that by 2007-8, the interbank cash market barely traded so Libor’s traditional definition had grown meaningless, while the interest rate swap market ‘wagged the dog’. The British Banking Association (which used to publish Libor) and regulators negligently allowed this false definition of Libor to persist.
These justifications didn’t save the banks, hence the fines. But the regulatory findings may have created a conflict with potential criminal prosecutions. Consider the example of former RBS money market trader Paul White. In addition to his trading responsibilities, RBS assigned White the job of primary submitter for yen and Swiss franc Libor.
As White told the FCA, he found it rather hard to remember which hat he was supposed to be wearing. It was impossible to ‘unlearn’ his own trading positions, and turn his brain into a tabula rasa when it came to making Libor submissions. As for the numerous messages in which he offered to shift fixings in other traders’ favour, this was just his attempt to humour people.
Tosh, said the FCA, banning White from the industry (if he had not shown evidence of ‘financial hardship’ the FCA would have fined him £250,000 as well). But this is based on a civil law evidence test. Imagine convincing a criminal jury that White knew he was acting fraudulently. This may be why the SFO has not taken action against any RBS trader so far.
If anyone should be held to account, it should be senior managers who subverted the Libor submitting process, creating a business model that made traders like White wear the hats that they did. Yet the SFO has made little progress extending its campaign of prosecutions deep into the managing director ranks where real investment banking power lies. The trail of evidence runs cold, and the Barclays trial is a case in point. Three senior bankers will be appearing at the trial, not as defendants but as witnesses for the prosecution.
One might argue that the billions in fines already represent punishment for the senior bankers, because they specifically reference business models put in place over the heads of junior staff. Then again, these fines are paid by bank shareholders, and not the senior bankers themselves. Unlike Hayes, who is losing £900,000 under a confiscation order, senior staff get to keep their wealth.
This brings us to Deutsche Bank, which so far has paid the biggest fines. Evidence suggests that Deutsche ran Libor rigging as a global business model par excellence. A report by German supervisor BaFin, currently only available as a leaked translation, mentions Christian Bittar, a trader whom the SFO announced last month would face criminal proceedings along with nine others. According to the report, Bittar had regular access to senior management.
If a jury is asked to ignore that, will they accept it? The Deutsche trial won’t happen for another 18 months, but the outcome of the Barclays trial may give an indication of whether the SFO strategy of picking on the small fish pays off.
