Introduction

Beginning in 2012, an international investigation into the London Interbank Offered Rate, or
Libor, revealed a widespread plot by multiple banks—notably Deutsche Bank, Barclays,
UBS, Rabobank, and the Royal Bank of Scotland—to manipulate these interest rates for
profit starting as far back as 2003. Investigations continue to implicate major institutions,
exposing them to lawsuits and shaking trust in the global financial system.

Regulators in the United States, the UK, and the European Union have fined banks more than
$9 billion for rigging Libor, which underpins over $300 trillion worth of loans worldwide.
Since 2015, authorities in both the UK and the United States have brought criminal charges
against individual traders and brokers for their role in manipulating rates, though the success
of these prosecutions has been mixed. The scandal has sparked calls for deeper reform of the
entire Libor rate-setting system, as well as harsher penalties for offending individuals and
institutions, but so far change remains piecemeal.

What is Libor?
Libor is a benchmark interest rate based on the rates at which banks lend unsecured funds to
each other on the London interbank market. Published daily, the rate was previously
administered by the British Bankers’ Association (BBA). But in the aftermath of the scandal,
Britain’s primary financial regulator, the Financial Conduct Authority (FCA), shifted
supervision of Libor to a new entity, the ICE Benchmark Administration (IBA), an
independent UK subsidiary of the private U.S.-based exchange operator Intercontinental
Exchange, or ICE.

To calculate the Libor rate, a representative panel of global banks submit an estimate of their
borrowing costs to the Thomson Reuters data collection service each morning at 11:00 a.m.
The calculation agent throws out the highest and lowest 25 percent of submissions and then
averages the remaining rates to determine Libor. Calculated for five different currencies—the
U.S. dollar, the euro, the British pound sterling, the Japanese yen, and the Swiss franc—at
seven different maturity lengths from overnight to one year, Libor is the most relied upon
global benchmark for short-term interest rates. The rate for each currency is set by panels of
between eleven and eighteen banks.

How does Libor affect global borrowing?

Many banks worldwide use Libor as a base rate for setting interest rates on consumer and
corporate loans. Indeed, hundreds of trillions of dollars in securities and loans are linked to
Libor, including government and corporate debt, as well as auto, student, and home loans,
including over half of the United States’ flexible-rate mortgages. When Libor rises, rates and
payments on loans often increase; likewise, they fall when Libor goes down. Libor is also
used to “provide private-sector economists and central bankers with insights into market
expectations of economic performance and interest rate developments,” explains the IBA, the
new Libor administrator.

Why and how did traders manipulate Libor?

Barclays and fifteen other global financial institutions came under investigation by a handful
of regulatory authorities—including those of the United States, Canada, Japan, Switzerland,
and the UK—for colluding to manipulate the Libor rate beginning in 2003. Barclays
reportedly first manipulated Libor during the global economic upswing of 2005–2007 so that
its traders could make profits on derivatives pegged to the base rate, explains
CFR’s Sebastian Mallaby.

During that period, “swaps traders often asked the Barclays employees who submitted the
rates to provide figures that would benefit the traders, instead of submitting the rates the bank
would actually pay to borrow money,” the New York Times reported. Moreover, “certain
traders at Barclays coordinated with other banks to alter their rates as well.” During this
period, Libor was maneuvered both upward and downward based “entirely on a trader’s
position,” explains the London School of Economics’ Ronald Anderson.

Hundreds of trillions of dollars in securities and loans are linked to Libor.

Following the onset of the global financial crisis of 2007–2008, Mallaby says, Barclays
manipulated Libor downward by telling Libor calculators that it could borrow money at
relatively inexpensive rates to make the bank appear less risky and insulate itself. The
artificially low rates submitted by Barclays came during an “unprecedented period of
disruption,” says Anderson. It provided the bank with a “degree of stability in an unstable
time,” he says. In 2012, as part of a settlement with U.S. and UK authorities, Barclays
admitted to “misconduct” in the manipulation of rates.

The investigation into the Swiss bank UBS focused on the UK trader Thomas Hayes, who
was the first person convicted for rigging Libor. Prosecutors argued that this allowed him to
post profits in the hundreds of millions for the bank over his three-year stint, after which he
moved to the U.S.-based Citigroup. After Hayes was arrested in December 2012, UK
politicians criticized UBS executives for “negligence” after the bank’s leadership denied
knowledge of the traders’ schemes due to the complexity of the bank’s operations. At the
same time, most of the fraudulent collusion occurred between Hayes and traders at Royal
Bank of Scotland (RBS), which is majority owned by UK taxpayers, to affect submissions
across multiple institutions.

What effect has the Libor scandal had on global financial

markets?
Many experts say that the Libor scandal has eroded public trust in the marketplace. Indeed,
securities broker and investment bank Keefe, Bruyette & Woods estimated that the banks
being investigated for Libor manipulation could end up paying $35 billion in private legal
settlements—separate from any fines to regulators. These sums could pose new challenges
for financial institutions that are increasingly required to maintain higher reserves to guard
against another systemic crisis. “It will be another blow to the banks’ ability to hold enough
capital to satisfy higher regulatory requirements in the wake of the financial
crisis,” writes the Huffington Post’s Mark Gongloff.

What have been the penalties for financial institutions?

A wave of Libor-related prosecutions, led by U.S. and European regulatory bodies, has led to
multiple major settlements. All told, global banks have paid over $9 billion in fines.

The UK’s Barclays settled a case with U.S. and UK authorities for $435 million in July 2012,
and in 2016 agreed to pay an additional $100 million to forty-four U.S. states for its role in
manipulating the dollar-denominated Libor rate. In December 2012, Swiss banking giant
UBS was slapped with the biggest Libor-related fine up to that point, paying global regulators
a combined $1.5 billion in penalties. The complaint, led by the U.S. Commodity Futures
Trading Commission (CFTC), cited over two thousand instances of wrongdoing committed
by dozens of UBS employees.

In early 2013, U.S. and UK authorities fined RBS $612 million for rate rigging. Then, in
December 2013, EU regulatory authorities settled their investigation into Barclays, Deutsche
Bank, RBS, and Société Générale, fining the latter three banks a combined total of 1.7 billion
euros, or over $2 billion. They were all found guilty of colluding to manipulate market rates
between 2005 and 2008. In exchange for revealing the cartel to regulators, Barclay’s was not
fined by the EU. JP Morgan Chase and Citigroup also became the first U.S. institutions fined,
albeit with much smaller penalties. (In 2016, a separate investigation by U.S. authorities fined
Citigroup $425 million after finding that senior managers at the bank knew about Libor trader
Tom Hayes’ illicit manipulation of the rate.) Also in 2013, Dutch Rabobank settled
charges against it for over $1 billion.

In April 2015, Germany’s Deutsche Bank agreed to the largest single settlement in the Libor
case, paying $2.5 billion to U.S. and European regulators and entering a guilty plea for its
London-based branch. It brings the total amount of fines paid by Deutsche Bank to $3.5
billion, more than twice that of any other institution.

Many of these same banks have also come under scrutiny for similar concerns that they
colluded to manipulate global currency markets. In May 2015, five banks—Citigroup, JP
Morgan Chase, Barclays, Royal Bank of Scotland, and UBS—pleaded guilty to criminal
charges of manipulating foreign exchange markets, agreeing to pay over $5 billion to the U.S.
Justice Department and other regulators. As part of that settlement, UBS pleaded guilty to
additional Libor-related fraud, paying $203 million in penalties. However, the Justice
Department did not indict any individuals at that time.

How have individuals involved been punished?

Investigations have placed most of the individual responsibility on the traders who sought to
influence the Libor rate, as well as the managers who encouraged them, the brokers who
helped carry out the schemes, and the rate-submitters themselves. As the extent of the Libor
fraud became clear, more than one hundred traders or brokers were fired or suspended. Bank
executives pled ignorance of the misconduct, but a number of them, including former
Barclay’s CEO Bob Diamond and Rabobank CEO Piet Moerland, have been forced out. As
part of its 2015 settlement, Deutsche Bank was obligated to fire seven employees.

However, regulators came under criticism for being slow to respond to the allegations, and
some politicians called for stiffer penalties for the individuals responsible. In 2013, for
instance, the UK’s then-Chancellor of the Exchequer George Osborne announced that he
wanted the fine for RBS to come out of bankers’ bonuses rather than taxpayer funds.
Over one hundred traders or brokers have been fired or suspended, and twenty-one have been
charged.

Since 2015, over twenty people have also been criminally charged in connection to Libor-
related fraud by both UK and U.S. authorities. The UK’s Serious Fraud Office (SFO) has
charged twelve people over Libor, beginning with the 2015 trial of Hayes. He was convicted
of leading a conspiracy by recruiting traders and brokers at other banks to manipulate Libor,
and was sentenced to fourteen years in prison. However, the SFO prosecutors faced a setback
in January 2016 when six of Hayes’ alleged co-conspirators, brokers at three UK firms, were
acquitted of all charges. Hayes is also appealing his conviction. In July 2016, a separate SFO
prosecution resulted in the conviction of three Barclays traders, who received prison
sentences of between two and six years. Other cases are ongoing.

The first U.S. convictions came in November 2015, with a New York judge sentencing two
former Rabobank employees to one to two years in prison. In June 2016, the DOJ indicted
two former Deutsche Bank traders and revealed that several others had pleaded guilty. In
total, the DOJ has charged sixteen people in connection to its Libor probe.

What are some implications of the Libor scandal?

Despite the scandal, Libor continues its role as the primary benchmark for global lending
rates. However, the efforts of authorities to increase the oversight and accountability of the
Libor system have spurred debate over whether reforms go far enough.

One of the first impacts of the Libor investigation was to raise questions over the role of
central banks, in particular the Bank of England, in failing to address, or even abetting,
problems with the system. As New York Fed economists David Hou and David Skeie
explain, the New York Fed communicated its concerns over Libor manipulation to the Bank
of England in 2008, and suggested reforms to the system that weren’t followed up. And in
2012, Bank of England officials strenuously denied allegations that the central bank had
encouraged some UK banks to underreport their borrowing costs at the height of the 2008
crisis.

As a result, the UK government began considering reforms to Libor, whose regulation, as a

London-based benchmark, falls under the UK’s purview. The UK Parliament passed
legislation in 2012 to strengthen financial regulation in general, and reform the Libor system
in particular. The 2012 law created the Financial Conduct Authority (FCA), a new
government agency with centralized and expanded powers to investigate and regulate
financial markets, including Libor.

Subsequent changes to Libor were based on the recommendations of a UK government report

led by UK financier Martin Wheatley, who became the first head of the FCA. While many
commentators in the United States argue that Libor had been totally discredited and should be
scrapped in favor of a new rate based on real transaction data, the Wheatley report advocated
more gradual changes. In addition to the creation of the FCA, these included the transfer of
Libor to a new entity, the ICE Benchmark Administration, increasing penalties for
manipulation, and a more transparent process for setting the rate. The Libor mechanism was
kept for existing contracts and new contracts were allowed to use either Libor or
a transaction-based benchmark rate until the ongoing reforms of the system are completed.
In that sense, according to the Wall Street Journal’s Francesco Guerrera, the 2012 Barclays
settlement could potentially hold the “seeds” of a new regulatory regime. As part of the deal,
Barclays “must now base its submissions on market prices rather than some hazy estimate of
borrowing costs,” he wrote. Administration of Libor has been shifted to ICE, which is
ultimately required to anchor its Libor calculations in more concrete transactions data which
would be more difficult to manipulate. That process is underway, with ICE having proposed a
system, still under development, to do so.