For Switzerland’s largest bank, the hits just keep coming. After years of being whacked with millions of dollars of fines for all sorts of infractions, UBS now appears to be at the center of the financial world’s latest scandal: an alleged conspiracy by traders and brokers to rig the price of derivatives around the world by manipulating a key interest rate.
The Wall Street Journal reports that UBS has admitted to Canadian regulators that between 2007 and 2010, some of its traders and cash brokers conspired to manipulate the London interbank offered rate, also known as Libor. This is the rate that banks use to lend to each other, and it is essentially the backbone of half the world’s fixed-income market, because it’s also used to calculate the price of trillions of dollars of floating-rate securities every day, from car loans to corporate bonds and derivatives.
By allegedly conspiring to set Libor rates, traders and cash brokers appear to have been able to profit off of derivatives linked to it. Bloomberg News reports that UBS recently suspended a number of senior executives and traders in conjunction with the investigation.
Despite its systemic importance, Libor remains a strange throwback to an insular system of clubby bankers sitting around determining rates. Every morning at 11 a.m. in London, panels organized by the British Bankers’ Association set the rate for 10 currencies, with a separate panel assigned to each currency. The agreed-on rate is supposed to represent a snapshot of banks’ willingness to lend to each other that day, as they suss out their own short-term cash needs.
The reports alleging manipulation by UBS involve the 16-bank panel responsible for setting the Libor rate for the yen. Traders at JPMorgan, Citigroup, HSBC, Deutsche Bank, and RBS were also allegedly involved in manipulation efforts. All six banks are on the yen Libor panel. Spokesmen for all six banks declined to comment when contacted by Bloomberg News this week.
The trouble lies in the fact that Libor is fundamentally a fictitious rate, since it is a benchmark rather than a real average. There’s no guarantee that’s the rate bankers will in fact use that day. They are not bound by it, and it is not representative of actual trades going on in the market. Since it’s the rate typically relied on by lenders, some feel that Libor is biased on the high side.
Traders wishing to manipulate Libor could in theory phone up a member of the panel prior to 11 a.m. and tell him what rate to propose, which is essentially what’s alleged. According to reports of court documents filed by Canadian regulators, traders at UBS, communicating with traders at other banks using e-mail and instant messaging, colluded on whether they wanted Libor to be set high or low on any given day. They would then pass that desire off to their bank’s representative on the Libor panel.
The whole thing raises major issues with the supposed “Chinese walls” that are supposed to divide investment banks’ traders from employees who make interest rate submissions on behalf of the bank. Bloomberg News recently reported that in some cases, these people actually sat close to each other.
On Feb. 7, UBS said that it received conditional immunity from the Swiss Competition Commission in relation to an investigation into the the manipulation of other benchmark rates. The U.S. Department of Justice has also granted UBS immunity protection.
Last fall, UBS paid fines of $8 million and $12 million in two cases involving indiscretions in the short sales of securities. In April, regulators ordered UBS to pay $11 million for misleading clients about the safety of debt issued by Lehman Brothers before it went bankrupt. In September, it was revealed that a London-based rogue trader cost the bank more than $2 billion. But the mother of all UBS penalties and screw-ups is the $780 million fine it paid in 2009 for helping wealthy clients evade taxes.
Terri Duhon, a London-based banking consultant who was part of the team at JPMorgan that invented credit derivatives in the early 1990s, believes the system of determining Libor retains its underlying value but should perhaps be rethought in light of the scandal. “Somewhere along the line, the system of checks and balances didn’t work. With the market tainted by so many other problems, and as people are trying to reestablish the value-add of the banking system, scandals like this don’t help.”