Barometer of Fear

by Alexis; Stenfors

  Other clubs were perhaps less elitist or formal. Nonetheless, membership in, say, Bank of England’s London Foreign Exchange Joint Standing Committee, or in the Canadian Foreign Exchange Committee, was highly exclusive. Minutes from the meetings (those that are in the public domain) read like a Who’s Who in the FX markets. The chief dealers at the major banks are there, and so are the central bankers. But the ‘market’ is notably absent, unless, of course, the market is purely defined as the dozen or so global banks that buy and sell the majority of those $5.1 trillion worth of currencies on a daily basis.

  In contrast to stock markets, therefore, activities in foreign exchange and interest rate markets are often managed through certain ‘clubs’. And it almost seems natural that the central bank becomes the logical manager of the club of banks.

  ***

  LIBOR, however, was different. Although the LIBOR clubs look strikingly similar to, say, primary dealerships in that a group of banks control a money-related instrument or price, the central banks lack authority. LIBOR has never been under the jurisdiction of a central bank, and until 2013 it had always lacked regulatory oversight. Due to its roots in the Eurodollar market, it could be argued that it was intended never to be under any government scrutiny at all. However, LIBOR was not self-regulated by the ‘markets’ either. However, this did not this imply that LIBOR lacked rules. What set LIBOR apart was that the LIBOR banks themselves, not the market, had authority. The group of LIBOR clubs had steering committees deciding upon the rules and structure of the benchmark. These committees consisted of, and were appointed by, the LIBOR fixing panel banks themselves. Although the LIBOR panel compositions changed over time (mainly as a result of bank mergers), the LIBOR clubs always included the large universal banks that were also the most active market makers in the money, FX and derivatives markets. Likewise, despite the differences in size (ranging from just five members in the STIBOR club to 43 in the EURIBOR club), they also tended to increasingly include international banks that were not under the direct jurisdiction of the central bank issuing the underlying currency for that particular benchmark. In other words, they were either typical so-called too-big-to-fail banks within a country, or international banks of gigantic proportions. For instance, 14 of the 18 members of the US dollar LIBOR club were classified as ‘global systematically important banks’.13

  The clubs, in turn, appointed an organisation to govern and supervise both themselves and the process. This was not the ‘market’ or any kind of financial regulator, such as the Securities and Exchange Commission (SEC) or the FSA. Instead, it was usually the prevailing banking lobby organisation in the country. The main objectives and tasks of the lobby organisations are, of course, to promote the interests of their members. For instance, the BBA (which governed LIBOR) aims to influence decision makers by ‘promoting a legislative and regulatory system for banking and financial services … which takes account of our members’ needs and concerns and provides an effective and competitive market place in which their businesses can prosper’. The banking lobby also ‘promote[s] and defends the [banking] industry’ by engaging ‘with government, devolved administrations and Europe as well as the media and other key stakeholders to ensure the industry’s voice is heard and to highlight the strength and importance of UK banking’.14 Among the guiding principles of the European Banking Federation (which governed EURIBOR in conjunction with the ACI) is ‘to promote the principles of self-regulation and better regulation within the EU, so as to alleviate the burden on banks’. The lobby also aims to ‘ensure that the experience and the views of banks are taken into consideration in the shaping of relevant policies’.15 The point is that the banking lobby is not working for the market, but for the banking industry. That the banks selected a lobby as the governing body for the most important financial benchmark in the world is logical, but also quite remarkable. As with many things in banking, the idea would be unthinkable in other industries. It would be the equivalent of the National Rifle Association being responsible for the supervision and governance of the US firearms industry.

  The BBA even managed to register the BBA-LIBOR as a trademark in the same way as Coca-Cola did with its famous contour bottle about 100 years ago. Just as the Coca-Cola recipe still remains a protected trade secret, the true ingredients of LIBOR were also fiercely guarded by the banks and the bank lobby. Following queries into the integrity of the LIBOR process in 2008, the BBA said: ‘It is not possible to receive the details of individual dealt rates as the confidentiality agreements between brokers and their clients preclude these from being disclosed.’16 After a more thorough review of the whole process, the following statement was released by the BBA:

  In conclusion, all contributing banks are confident that their submissions reflect their perception of their true costs of borrowing, at the time at which they submitted their rates. They are therefore prepared to continue with their individual quotes being published with the day’s LIBOR rates. As there was no real support for any of the proposals to limit stigmatisation, the FX & MM Committee has therefore decided to retain the existing process.17

  The integrity of LIBOR (or the lack of it) was protected by the clubs or by the associations working on their behalf. It should not come as a surprise that the lobby organisations often acted as defendants on behalf of the banks with regard to the integrity of the LIBOR fixing mechanism, despite pressure from individual non-member banks and end users such as pension funds, corporations and hedge funds.18

  The LIBOR rate-setting process was always secretive by nature. Banks did not have to provide any evidence that their submissions were accurate. In fact, actual trades between banks are considered trade secrets. Even so, to prevent unnecessary suspicion, banks actively tried to conceal what they were up to. When, on 29 May 2008, the Wall Street Journal reported that banks might have been manipulating LIBOR rates, panel banks were quick to refute the claims.

  ‘We continue to submit our LIBOR rates at levels that accurately reflect our perception of the market,’ a Citi spokesman said.19

  This was a far cry from what was being discussed within the bank, though.

  ‘WSJ article on LIBOR getting a lot of attention. So under pressure to be in middle of pack so will be moving up a couple today,’ a Citi US dollar LIBOR submitter had commented, according to transcripts obtained by the regulators.20

  Being in the ‘middle of the pack’ basically meant submitting LIBOR rates similar to the average of the others, regardless of their accuracy.

  HBOS, the British bank later acquired by Lloyds Bank, also argued that the contents of the newspaper article were unfounded. The official statement argued that the bank’s LIBOR quotes were a ‘genuine and realistic’ indication of its borrowing costs. The word on the trading floor was somewhat different. Just three weeks before the article was published, an HBOS senior manager sent an email to two other senior managers and other HBOS personnel, including the senior manager of the LIBOR submitters, saying: ‘It will be readily apparent that in the current environment no bank can be seen to be an outlier. The submissions of all banks are published and we could not afford to be significantly away from the pack.’21

  Banks not only mislead customers and the wider public. Deutsche Bank, for instance, went so far as to mislead the lobby and the financial regulator. On 4 February 2011, the Financial Conduct Authority (the FCA, which had replaced the FSA) sent out a request to all LIBOR panel banks asking them to confirm that they had proper systems and controls in place for the submission process. Two months previously, the BBA had asked all banks to confirm that an audit had been carried out; this was signed by a compliance officer at Deutsche Bank. That, however, was incorrect. There had been no audit of LIBOR. Instead, the compliance officer had said in an email that the BBA confirmation was ‘an arse-covering exercise [by the BBA]’.

  Deutsche Bank sent a signed document to the regulator on 18 March 2011, claiming that it had ‘conducted spot checks on a random sample of LIBOR submissions across
a number [of] currencies’ and that the bank ‘monitor[ed] all email and instant messaging communications of all front office staff’. In sum, it was concluded that the bank had ‘adequate systems and controls in place for the determination and submission of Deutsche Bank’s LIBOR fixings’. This was also incorrect. The bank had not conducted any spot checks on LIBOR submissions. The bank did not have adequate systems and controls in place. The bank did not include any LIBOR-specific terms in the monitoring of communications of front office staff. Moreover, the FCA also found that Deutsche Bank had failed to give accurate information regarding audio recordings, and even shredded important documents that were required to be stored, according to the regulator.22

  ***

  Although I was very active in trading various LIBOR derivatives, I was either working for a bank that did not belong to any LIBOR clubs (Merrill Lynch in London), working for a bank that belonged to LIBOR clubs in other countries (HSBC in Stockholm), working for a bank that belonged to LIBOR clubs in other currencies (Crédit Agricole in London) or working for a bank that belonged to various LIBOR clubs but I was located on a different trading floor or within another trading entity (Citibank London and Tokyo).

  If a non-member wanted change, they could of course try to become a member of one of the clubs. This would have given the new member not only a VIP card to be part of the process in determining LIBOR, but would also have provided them with a voice in the meetings where decisions regarding the whole structure were made. However, a membership card was incredibly difficult to obtain.23 First, it was not enough that you had exposure to LIBOR or could claim to be a financial institution. You had to be a bank, and a bank with a good credit standing. Second, you needed to be a very large bank. You had to show that your trading activity was ‘sizeable’, which meant that small and medium-sized banks would be disqualified even before the application process started. A third hurdle was ‘market-making ability’. To act as a market maker in a specific currency, you had to be either a very large domestic bank or one of the few universal banks that had extensive local expertise everywhere in the world. Some clubs also required branch presence in a particular country.

  Once, a trader at RBS called me to tell me he was keen to take the initiative in getting his bank to join one of the LIBOR clubs. RBS was a big bank. RBS had a sizeable trading activity. RBS was a market maker. When he called back a while later, I patiently listened to him as he furiously told me that they had been rejected because of a lack of branch presence. I did not really know what to say. At various points during my career, I had started inquiries into whether it might be possible to join a few of the clubs. Every time I was rejected even before seeing a proper application form.

  The clubs and their governing bodies were almost like secret societies. Outsiders knew they had influence and power. But the rituals and formal tests you had to pass in order to become a member, or just to attend as a guest, were too difficult. In the unlikely event you passed, you were still met by an informal resistance among the existing members to broaden or diversify the membership roster. ‘Reputation’ in the market belonged to more informal criteria. In hindsight, we now know that the reputation requirement had little to do with reputation outside the clubs. Despite numerous fines, lawsuits and criminal investigations since 2013, the club members have remained almost precisely the same and their members continue to submit LIBOR quotes on a daily basis. None of the banks have been disqualified for lack of reputation.

  No major overhaul, or rule change, with regards to LIBOR took place from its inception to the aftermath of the scandal. A few groups of banks retained exclusive privilege to influence LIBOR throughout these decades. And the same clubs managed to keep control of the rule book. In that sense, LIBOR was a fundamentally anti-competitive process from the start, which then benefited from deception, secrecy and disguising itself as a competitive and free market. The status quo of maintaining control over the underlying benchmark while keeping its integrity intact probably suited the banks’ interests and gave them a kind of ‘secret power’. Or, as Steven Lukes, a sociologist, once said: ‘[T]he most effective and insidious use of power is to prevent such conflict from arising in the first place.’24

  However, power and secrecy stretched beyond the world of benchmarks that were used in derivatives, mortgages, corporate debt, student loans and central bank policy. They also ensnared the largest market in the world: the foreign exchange market.

  CHAPTER 6

  CONVENTIONS AND CONSPIRACIES

  In 1995, I was sent to the HSBC Group Management Training College in Hertfordshire to learn the basics of foreign exchange trading. It was nice to leave dark and icy Stockholm behind for two weeks to join 15 or 20, mainly London-based, soon-to-be traders and sales people in the leafy English countryside. HSBC was very good at FX, probably in the top three in the world at the time, so my expectations of the course were high. We got to play a computer-based trading simulation game, designed to replicate a realistic situation in a dealing room. It was fun, and the teacher was both knowledgeable and engaging. I remember how we were repeatedly told to ‘galvanise our HPs’, as if our calculators (manufactured by Hewlett-Packard) were like musical instruments needing to be restrung before a concert. We had to practise, practise, practise – to master the most difficult mathematical problems that could arise in FX and money market trading. However, after a day or two I think most of us found the classes rather tiresome. The young orchestra – wanting to play, rather than simply learn the chords – became frustrated and began to miss the buzz of the London dealing room, even if at this stage of their careers they probably did little more than tea and sandwich deliveries for the desk. I just felt lucky to be there, but perhaps also a little looked down on by some of the others who, I thought, saw me as an unsophisticated relative from some distant wilderness. Frustration turned into desperation, and one night, after we had stayed up chatting and bragging, someone had the idea of breaking into the bar inside the training centre; as with everywhere else in England at the time, it had closed at 11 p.m. Two fearless traders-to-be turned the vision into reality by somehow managing to find an entry point. Perhaps the bar had been left unlocked? I cannot remember more than the fact that soon thereafter the drinks were flowing. ‘Gold’ by Spandau Ballet was playing on the sound system. Even now, whenever I hear Tony Hadley singing about being ‘indestructible’ I cannot help but wonder what happened to my classmates when they got back to London. I am not just thinking about the two mischievous ringleaders, who seemed both ruthless and smart. Any trading desk would have been delighted to have them on board, and I doubt the incident was ever reported. No, I am thinking about those who cheered them on, who tried to persuade them to stop, or who, like me, neither actively helped nor actively prevented it from happening. Those who just happened to be there.

  ***

  In November 2014, six global banks received fines totalling $4.3 billion for manipulative trading conduct in the FX markets.1 Despite the incredibly large fines, which matched or even trumped those in relation to LIBOR, things were by no means settled. ‘This isn’t the end of the story,’ said Martin Wheatley, then head of the FCA.2 The six banks were HSBC, RBS, UBS, JPMorgan Chase, Citibank and Bank of America. I had worked for half of them: HSBC, Citigroup and, technically, Bank of America after they bought Merrill Lynch. On reading about the fines, I remembered the HSBC training course I had participated in almost 20 years earlier. Not that it had anything directly to do with the FX scandal the whole world was now reading about in the newspapers. Instead, I thought about how black and white everything looked from the outside. Before this day, LIBOR seemed to have been the problem, and the FX market had not. Some banks had paid large fines for manipulating the FX markets whereas other banks had paid nothing. Some FX traders were mentioned in the transcripts (again, without revealing their true identities) whereas others were not. You were either innocent or guilty.

  To me, LIBOR derivatives and FX had always been extremely closely con
nected. Traders in the two markets always fed off each other, sat close to each other, or, like me, were equally involved in both. Camaraderie was mixed with enmity in a peculiar way, and once you were ‘inside’, the world was fluid rather than solid, grey rather than black and white. The rules were different from those followed in the rest of society and evolved differently. The problem was that these rules, having become almost conventional for those who abided by them, looked from the outside like a crystal-clear case of conspiracy.

  Earlier, just a few months after the LIBOR scandal broke in 2012, I met a former colleague who was now a managing director in foreign exchange sales at one of those six banks. We had both been ‘inside’, and our discussion quickly gravitated away from LIBOR and towards FX.

  ‘Just imagine all the shit they would find if they began digging into FX,’ he said.

  He was not referring specifically to the manipulative practices that have been made public by regulators and lawmakers since then, but more generally to the perception of the FX desks as the Wild West of the various dealing rooms across the City, in Canary Wharf and elsewhere around the world. FX trading was like nothing else, yet it had hitherto managed to escape the attention of the media. Strange, but it was only a matter of time before it was in the firing line, we both thought. The FX market did not have a particularly bad reputation. It was just that it had a different ‘culture’, something that the more well-behaved stockbrokers and equity analysts on the trading floor would often comment upon. If they, with their knowledge and experience, found the culture sometimes questionable, surely the person on the street who was not familiar with dealing room practices would be interested in knowing what really went on.