LIBOR and EURIBOR scandal, a critical evaluation

The purpose of this document is to perform a critical evalution of what is called the LIBOR and the EURIBOR scandal. The primary reason is to understand who performed any wrong doing. The problem is what you read in the dutch papers is not clear. However what is worse the documents issued by the European Union are not clear The Following documents are discussed: Critical Evaluation Antitrust: Commission fines banks € 1.71 billion for participating in cartels in the interest rate derivatives industry Critical Evaluation Antitrust: Commission fines banks € 1.71 billion for participating in cartels in the interest rate derivatives industry - frequently asked questions Critical Evaluation Libor scandal in Wikipedia.
Antitrust: Commission fines banks € 1.71 billion for participating in cartels in the interest rate derivatives industry (IP-13-1208)


For a copy of the document select: IP-13-1208 This document starts with the text:: The European Commission has fined 8 international financial institutions a total of € 1 712 468 000 for participating in illegal cartels in markets for financial derivatives covering the European Economic Area
The subject is cartels and derivatives. Derivatives have to do with all types of trades. The document mentions illegal cartels. Ofcourse if cartels are illegal than the people involved in those actions should be punished. It is doubtful if fines are the real answer, because in that gain the money goes to the gouvernment which most probably did not occur at a loss. Cartels are agreements between companies, but this does not mean that this is bad. In the airline business many companies have partners, is that bad? In the medical industry in research is it wrong if companies discuss what research they are going to perform? It is strange that no details are supplied exactly what is wrong.: Joaquín Almunia, Commission Vice-President in charge of competition policy, said: “What is shocking about the LIBOR and EURIBOR scandals is not only the manipulation of benchmarks, which is being tackled by financial regulators worldwide,
Benchmark have typical to do with computer simulations. Based on inputs and an algorithm (a set of calculations) outputs are calculated. In many cases the inputs are a function of time, that means you can calculate situations in the future. If a benchmark (test) is performed to test the solvability of a bank and the bank purposeful suply wrong financial data, the people involved should be punished. Next is written:: but also the collusion between banks who are supposed to be competing with each other.
Again the same problem: Why should banks compete with each other? Most customers do not have the capabilities to find out which bank is the best. What they expect: If they have to borrow money to pay a low price. If they have to save money to get a high price.: Today's decision sends a clear message that the Commission is determined to fight and sanction these cartels in the financial sector.
The problem is that the Commission should investigate all what is happening inside the banks. Every one is dependent on what banks are doing. Bank in turn should understand that nothing what they are doing is any special.: Healthy competition and transparency are crucial for financial markets to work properly, at the service of the real economy rather than the interests of a few.
What is the difference between healthy competition and competition.
Competition is almost always a challenge at the benefit of some and at the disadvantage of others in the same area of interest. Consumer good stores reduce prices with the intention to get more customers and or to increase profit. Often they do that by buying cheaper products, reduce service or outsourcing.
Healthy competition is something which consists only of winners and no loosers. IMO this is a dream.
Transparency implies openess and that is what competition does not allow. Competition implies secrecy. You do not want the other companies to know what your future plans are in which areas you are investing because than you loose your advantage. In the paper and pulp industry there is much less competition because the amount of raw material (wood) is limited.
I do not know what the definition is of: "financial markets work properly". For banks the most important is that their products are transparent. This implies that the products of the different banks are the same. This inturn implies that banks should not compete with each other. The general rule should be that banks in all aspects are transparent and that openess is the rule.: Interest rate derivatives are financial products which are used by banks or companies for managing the risk of interest rate fluctuations. These products are traded worldwide and play a key role in the global economy. Investment banks compete with each other in the trading of these derivatives.
What the European Union should forbid is that banks trade their risks. The problem is it is easy to sell a risk and play simple, but difficult to evaluate by the buyer exactly what the risk is. Banks, all over the world, are dealing in mortgages with their customers. This type of business is important and involves a risk. However banks should not sell this risk. If they need more money they should follow different paths to get more money (Shares or bonds) or temporarily stop their mortgage business. Exactly the same applies in the insurance business. If certain deals are to large to handle than the item involved should be cut in smaller pieces. Each insurance company should be responsible for his own piece.: The EIRD (Euro interest rate derivatives) cartel aimed at distorting the normal course of pricing components for these derivatives.
The problem is that there are no details of what exactly happened. Only accusations is not clever. The fact that certain parties make certain agreements is not bad by defition. The problem is that when there is competition and you are supposed to select the cheapest offer than that is not by definition the best offer. Direct thereafter we read:


: Traders of different banks discussed their bank's submissions for the calculation of the EURIBOR as well as their trading and pricing strategies.
The issue is here how traders calculate the EURIBOR interest rate. (See: Libor (EURIBOR) interest ). When you read this sentence face value than what is wrong?
I guess that:

All banks will (roughly speaking) calculate this interest rate in the same manner.
Many of those traders have worked in different banks or have friends who can tell them how it is done overthere.
The different Universities will teach courses how to calculate LIBOR interest or how to trade stocks at a stock exchange.: The traders involved also exchanged, on occasions, commercially sensitive information relating either to trading positions or to future JPY (Japanese yen) LIBOR submissions
In a certain sense what those traders did they made the whole process more transparent. In this process there are three parties involved: You have a group of people who are involved in the calculation in the LIBOR interest. This are the representatives of the banks. You have traders. Each bank has traders. Those traders are handling the deals (buy or sell something) of their customers. You have customers. Each bank has its own customers. The customers are the persons who want to buy or sell something. In principle a customer can also be a bank. That means a bank can also buy and sell something using a trader that works for the same bank. The problem starts when a trader starts to buy and sell something because he knows that a customer of the bank has plans to buy and sell in the future. Collectivily this is called foreknowledge. All trades by traders where outside parties (other banks) are involved should be forbidden and should be handled by independent parties.

Antitrust: Commission fines banks € 1.71 billion for participating in cartels in the interest rate derivatives industry

frequently asked questions (Memo-13-1090)

For a copy of the document select: Memo-13-1090

What role do derivatives play in the European economy?

This document starts with the text:: Derivatives are contracts traded on financial markets that are used to transfer risk.
In the production process there are raw materials, intermediate products and the final products. In the normal chain of events the suppliers are paid when products are delivered. However also other possibilities are open. The supplier can be paid in advance to deliver products in the future. With this advance the supplier can buy his raw materials now and be sure that he has money availble to pay for his cost of living. Those agreements can be made directly between suppliers but also banks or other financial institutions become involved. In fact there are two communication channels. One communication line of products. This is a transfer of goods by land, by water or by air. This communication line is rather clear. To reduce risk the transport companies take insurance to be sure that in case the products are not delivered the suppliers are getting paid. One communication line of money between different parties and countries. This communication line is less clear. The transfer of money can be done: before, at the same time, or after the goods are delivered. The definition of what the goods are can be faque Or even the money itself can de subject of trade next we read:: They are of key importance for the European economy.
Of primary importance for the European economy is produce goods equally in all the countries Europe. The second most important is that companies should get loans to make investments and to buy raw materials. What is also important is that people should get mortgages to get loans to build new houses or for maintenance. In fact all financial transaction directly involved between the users of goods and services are important. What is much less important are financial transactions between different financial parties. This is the case when the buyers of those products (in case of derivatives) have no knowledge of the value of the goods involved and of the risks involved. This is also the case when you trade financial products in general.: This is because they serve as insurance against price movements and reduce the volatility of companies' cash flows, which in turn results in more reliable forecasting, lower capital requirements, and higher capital productivity.
This may be true in principle for some aspects but not necessary for all.: Derivatives have in recent years developed into a main pillar of the international financial system and are an indispensable tool for risk management and investment purposes.
When derivatives are traded international you are at the brink of collapse. The EU should warn against this trade. Derivatives are only important to make direct investments.

What is the interest rate derivatives market? What is the importance of this market?

The most common basic interest rate derivatives are: forward rate agreements, interest rate swaps, interest rate options and interest rate futures. Interest rate derivatives may be traded over the counter ("OTC") or, in the case of interest rate futures, exchange traded.
Why all these products? The main group which will benefit from all of this are the traders them self. For the rest this are all costs for the normal customers of a bank.: Interest rate derivatives products are used by corporations, financial institutions, hedge funds, and other undertakings to, among others, hedge their exposure to interest rates fluctuations.
That means all those companies do not have enough cash and need loans to buy something. They are speculationg on future profits to pay of these loans. The profit of one party is the loss for an other party. This has almost nothing to do with the original farmer who needs a loan (derivative) to buy raw materials. What is the scope of the two cartel cases?: The conduct established by the two decisions relates to anti-competitive conduct of traders in financial derivatives products tied to the respective benchmark interest rates.
That is all. The specifics are not supplied. Why this secrecy? Are banks liable for the behaviour of their traders under EU competition law?: Banks, like any other undertaking, are liable for the behaviour of their employees under EU competition law.
Banks are always responsible for the behaviour for their employees. Banks should train their employees and set up the rules and regulations to follow. If employees do not follow those rules the employees are responsible. Banks should be insured against possible misconduct by their employees.: no express instructions by the banks' management are necessary for an undertaking to be liable for the conduct of its employees.
Why such a cryptic sentences? What is leniency? What are the benefits of the Commission's leniency programme?: The Commission's leniency programme is its main and most effective tool to detect illegal cartels. All major competition agencies have a leniency programme and its optimal functioning is considered to be paramount to the success in the authorities' fight against cartels. Because most cartels are operated in secret, detecting cartels is a major challenge.
The fact that you have leniency programs means that there is something wrong in the business. What the EU should do is clearly identify how business in general within the EU should be performed and what is considered illegal. At the same time the EU should also specify the punishment for the people involved. That means within a company not only the people directly involved but also their management. If companies are performing illegal actions than the persons involved in this type of actions should be punished and not the companies.

Libor Scandal in Wikipedia

The scandal arose when it was discovered that banks were falsely inflating or deflating their rates so as to profit from trades,
And what is so fraudulent about that? Exactly when is the number that you write on a piece of paper true or false? Finally, where it boils down to, is that the objective of any bank is to profit from trades. Not to loose money. Reference #3 is the document: Libor scandal explained and what rate-rigging means to you claims:: At the heart of the controversy: Some banks artificially inflated or deflated their rates, depending on what would benefit them most. Some may have deflated their rates to give the impression that they were more creditworthy than they actually were.
It is almost always the same story: No clear facts. No details. Reference #6 is the document: Barclays Bank PLC Admits Misconduct Related to Submissions for the London Interbank Offered Rate and the Euro Interbank Offered Rate and Agrees to Pay $160 Million Penalty claims:: According to the agreement, Barclays provided LIBOR and EURIBOR submissions that, at various times, were false because they improperly took into account the trading positions of its derivative traders, or reputational concerns about negative media attention relating to its LIBOR submissions.
It is almost always the same story: No clear facts. No details.

Literature

The following document shows excellent course training material about what derivatives are: Chapter 9. Deratives: Futures, Options and Swaps
To see what all the subjects select: Economics Money & Banking Spring 2008
In the first document you can read (Example 1):: Southwest pays $3 per gallon no matter what, so they can price airline tickets accordingly. In reality, Southwest is pretty good at hedging jet fuel prices in the futures markets, which is one reason why they are one of the most profitable airlines in the industry.
Suppose the price now of a gallon is $2.70
Example 1 shows the situation when you buy now for $3 per gallon fuel to be delivered in 3 months. When in 3 months the price is above $3 you make a profit. When the price is below $3 you make a loss, because you have payed too much.
This means that you have too estimate now what the price is in 3 months. This is I think very dificult and maybe nobody knows.
The similar situation happens for the supplier of the fuel. Why should he sell now for a price of 3$ when the prices are rising?
What is not mentioned in paragraph derivatives if all airline companies work with derivatives. If that is the case you are forced to make deals, because when you don't in 3 month time there is nothing to buy.: Speculators are essentially sophisticated gamblers, betting on future price movements and trading futures contracts in order to make money. While hedgers trade futures contracts to manage risk, speculators take on risk when trading futures contracts. Speculators are essential for liquidity in the futures markets: Without them, there would not be enough buyers and sellers to make the markets work. Derivative securities are attractive to speculators because they have a great deal of leverage. With only a small initial outlay, speculators can take a futures position that has the same returns of buying 30 times the same amount of the underlying asset.
Derivative trading is important in the production chain in order to buy and sell raw and intermediate materials.

When this trading is done directly in between the different producers nothing is wrong.
When inbetween each trading deal one financial institution (like a bank) is involved also nothing is wrong.
When part of this trading is only between financial institutions (parties) the process becomes more fuzzy, because your only objective is to make a profit. The product is of much less importance.
In this situation IMO you always need two contracts.

One contract now to buy goods (which you do not have) and
a second contract now to sell those same goods (which you do not want).
For example:

First you can buy the goods now for $3 to be delivered in 6 months and
Secondly, you sell those same goods after 3 months for $3.30 and you will make a profit
The risk is here the assumption that the market price should rise.
A more complicated strategie is at the day you sell the goods immediate to buy different goods.
The question is: Is this type of speculation good for the economy? The ethical issue is that all the people directly involved in the production chain should be honestly paid

LIBOR (EURIBOR) interest

LIBOR which means: "London Interbank Offered Rate", is the interest rate used by a group of English banks to lend money among them. This interest rate can be valid for one day or one month and is defined by a group of bankers, each of which is responsible for one bank. These bankers meet each day. The procedure is simple. Each banker has an enveloppe. In the enveloppe is a sheet with a number and that number is the interest rate. They give the enveloppe to the chairman. The chairman removes the sheets with the 4 highest and 4 lowest numbers and calculates the average of the remaining numbers. The result is the interest rate for the next day.

I do not know the details how a bank calculate its number but I expect that within a bank a group of financial experts are busy with this subject.
The issue is the exposure to the currency (Euro's or Yen's) for the period in question. What you have to do is to predict the demand or supply of the currency in the future based on information reflecting the past and as a result your bid of the interest rate will be higher or lower

If the demand is higher than the supply (that means the bank has to buy) you want a lower interest rate and your number will be lower.
If the demand is lower than the supply (that means the bank wants to sell) you want a higher interest rate and your number will be higher.

Of course in the bank in this whole process many people will be involved. There is nothing obscure in this. Ofcourse you have to describe everything in great detail how the results are calculated such that everyone would do the same and nothing is based on subjective experience or facts.

As already mentioned above that it is very difficult to perform fraudulous actions within this scheme
Suppose a bank has too much cash. What you want is a high interest rate. That is what you do.
When it is too high it is not used or it is still used.
When a bank has not enough cash, the result will happen. The overall result can be that there is no change in the interest rate. What is the fraud?

Original: 6 December 2013

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