2012

ETHICS REPORT
[THE LIBOR SCANDAL: ETHICAL ISSUES]
The best way to rob a bank is to own one

LIBOR SCANDAL Introduction LIBOR stands for London Interbank Offered Rate. It is produced for ten currencies with 15 maturities quoted for each - ranging from overnight to 12 months - thus producing 150 rates each business day. Rates contributed by 18 banks listed below: Bank of America BNP Paribas Credit Suisse JP Morgan Chase Royal Bank of Canada Norinchukin Bank Bank of Tokyo-Mitsubishi UFJ Citibank NA Deutsche Bank Lloyds Bank Socit Gnrale Royal Bank of Scotland Barclays Bank Credit Agricole CIB HSBC Rabobank Sumitomo Mitsui Bank UBS AG

Each day between 1100 and 1110 hrs London time banks contributing to the LIBOR-setting process send their interbank borrowing rates directly and confidentially to Thomson Reuters. Thomson Reuters undertakes checks, discards the highest and lowest contributions (the top and bottom quartiles), and then uses the middle two quartiles to calculate an average. This methodology is sometimes called a shaved mean or a trimmed mean. On each London business day this process is followed 150 times to create the LIBOR rates for all the ten currencies and 15 borrowing periods (or maturities) in which the LIBOR rate is set. These figures are then distributed by Thomson Reuters by midday London time. Thomson Reuters makes public all contributions, including the outliers in the top and bottom quartiles, and these can be seen on a range of financial vendor screens around the world. The whole process happens under the supervision of the British Bankers Association (BBA). It is a benchmark used by banks, securities houses and investors to gauge the cost of unsecured borrowing in the London interbank market. LIBOR is the basis for a range of financial instruments including floating rate loans of various kinds, interest rate swaps, currency swaps, etc. Over $350 trillion dollars of financial products are tied to the labor. The Libor is supposed to be an overall assessment of the health of the financial system because if the banks being polled feel confident about the state of things, they report a low number and if the member banks feel a low degree of confidence in the financial system, they report a higher interest rate number. MECHANICS OF THE SCANDAL There were a series of fraudulent actions connected to the LIBOR and the resulting investigation and reaction. The scandal arose when it was discovered that banks were falsely inflating or deflating their rates so as to profit from trades, or to give the impression that they were more creditworthy than they were. LIBOR underpins approximately $350 trillion in derivatives.

Because Libor is used in U.S. derivatives markets, an attempt to manipulate Libor is an attempt to manipulate U.S. derivatives markets. Since mortgages, student loans, financial derivatives, and other financial products often rely on Libor as a reference rate, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide. On July 27, 2012, the Financial Times published an article by a former trader which said that Libor manipulation has been common since at least 1991. If one bank manipulates the interest rate, it would not affect LIBOR owing to the system of excluding the outliers. Therefore, to manipulate LIBOR substantially it had to be a cartel of banks manipulating interest rates in their interest. The discovery of the scam was following with the interrogation of the top management Barclays Bank followed by a series of resignations, including those of Marcus Agius, chairman of Barclays Bank and Bob Diamond, the chief executive officer of Barclays Bank. By 27 June 2012, Barclays was fined over $400 million

ETHICAL ISSUES Following law in word and in spirit The problem is not with the law, but with the ability and willingness to enforce it The law is a key aspect when it comes to enforce or maintain ethical behavior. However, it is on individuals to follow or flout the law. Going against the law can bring about punitive action. The exposure of the Libor scandal led to heavy fines on the incriminated banks and resulted in the resignation of key people in the top management. However there is only as much a law can do. Flaws due to system constraints are difficult to do away with. There are three 3 key parameters to be discussed in relation to this; Resources: The resources themselves are in question. The Libor rates are calculated by the BBA relying on only a gentlemans agreement. Top quality talent: The top management of the banks must have been clearly aware of the manipulation of interest rates. It is very difficult for any organization to remain ethical with the top management resorting to malpractices. Top quality talent can be misused for the wrong reasons. Deterrence: Since the rates are determined by the free market and there is no influence of the government, the system is open to a cartel. Regulations and compliance is required as a deterrent to malpractices. Misconduct Libor submissions were influenced in favor of Barclays trading positions. Barclays also manipulated the rates during the 2008 subprime crisis to show to the public that they were in a financially healthy position. Not only that the panel of banks determining Libor also

attempted to manipulate EURIBOR submissions. Obviously when the scandal was exposed there was a marked reduction in LIBOR submissions over concerns of negative media comment. The banks were still attempting to protect their clean image. Market Manipulation Barclays attempted to manipulate LIBOR to give a false impression of the banks health and also to benefit its trading positions. Banks in the Libor panel colluded for personal benefits at the expense of common taxpayers. Conflict of interest There was one prime reason leading to conflict of interest. One was the interest to uphold stakeholder faith and on the other to feed the needs of greed. It was unlawful profit against the commitment as loyal financial institutions to the faith of the general public. In the end, Libor submissions were tailored to meet the needs of its trading desk rather than offering good-faith estimates. Societal Expectations There are few questions that need to be asked here. What the broader community expects of its banks and their regulators? Does the fact that only the middle class was victimized, justifies the little protest? Does inappropriate behavior deserve attention only when it snowballs into multibillion dollar amounts?

The society puts a lot of money into the expert hands of financial institutions in good faith. With great power comes great responsibility. These institutions are the ones competent to help the society grow financially. However, if they misuse the power from their own good the society stands to lose a great deal not only in money but also in trust. Integrity Integrity of interest rates, the banks, the traders involved was compromised. It is well understood that a free enterprise require fidelity and trust. A free enterprise is faster in decisions and is influenced greatly by market conditions. However, there is no role of the government. Sometimes the market, however, forgets the interest of the public. Reprehensible acts such as unlawful collusion for market manipulation appear.

THE LEGAL ISSUES Inspite of being one of the most important benchmarks of the financial world, LIBOR remains largely unregulated. It is governed more by trade conventions and trust rather than being regulated by laws and regulations. This irony in its place, the banks participating in LIBOR are governed by laws, rules of conduct of business laid down in the UK Financial

Services and Markets Act and rules made by UK Financial Services Authority and other relevant laws and regulations. The misrepresentation of LIBOR amounts to several violations, few of which are described below: Financial Services and Markets Act 2000 Section 397 Misleading statements and practices, including, false, deceptive, or a reckless promises, statements and forecasts Inducing a person to enter into or refrain from entering into an agreement False or misleading impression as to the market in or the price or value of any relevant investments Financial Services Authority - Principles for business Principle 1: Integrity Principle 2: Skill, care and diligence Principle 3: Management and control Principle 5: Market conduct Fraud Act, 2006 Section 2 Dishonestly making false representation with an intention of making gain for himself or to cause loss to another or to cause risk of loss to another Violation of several guidelines of US Securities Exchange Commission, Futures Trading Commission and other related Laws Pursuant to above, following are the settlements reached by Barclays Bank, the first bank to be investigated: $200 million penalty for attempted manipulation of and false reporting concerning the Libor and Euribor benchmarks, by USFTC $160 million penalty to resolved violations arising from Barclays Libor and Euribor submissions, by US department of Justice 59.5 million relating to is Libor and Euribor submissions, by U.K. Financial Services Authority Total $ value of fine amounting to approx $453 million Further, the conduct of Barclays Banks and other banks amount to several civil claims, some of which are listed below: Antitrust litigation US Sherman Act 1 r/w US Clayton Act 4 Hurt business of small banks Derivative transactions Shareholder claims Common law Claims Securities Fraud Class Action claims US Racketeer Influenced and Corrupt Organizations Act - Interference with Economic Advantage and Breach of the Implied Duty of Good Faith

The Regulatory Response Post-LIBOR scandal, BBA has agreed to surrender the responsibility of conducting LIBOR calculations. As per the Wheatley Review recommendations, a Financial Services Bill proposed, which envisages establishment of Financial Conduct Authority to oversee and regulate LIBOR operations with appropriate powers. The aforementioned S 397 of FSMA is proposed to be repealed and replaced by two offenses. Further, a third offense is proposed to be introduced with respect misrepresentation specific to regulated benchmarks (such as LIBOR). Futher a Prudential Regulatory Authority shall be established for regulating prudential norms of conducting business. FSA will continue to remain umbrella regulator with appropriate powers.

CONCLUSIONS AND RECOMMENDATIONS To start, there is a need for tighter regulations. But it doesnt end there. Much of the incentive for the scandal was the commensurate benefit to the investment banking arm of these banks. It has been suggested separation of investment banking and commercial banking activities and ban same group having both business. However, that would be a regressive step and bringing the size of economy and financial sector substantially. Rather, what is needed is to have proper establishment water-tight compartments with strict regulatory oversight, in order to maintain independence between commercial banking and investment banking businesses of the same group, without hurting the overall financial sector. Further, there needs to be measures to ensure market discipline. Last but not the least, this scandal exemplifies that ethical dedication of a person, natural or legal, cannot be taken for granted. We need a system of checks and balances to ensure that the ethics are not compromised for greed of businesses.