Many months after the event, the Australian financial press has woken up to the fact that there was a financial scandal happening elsewhere. Worse still, it may also have happened here. The tabloid-like headline indicates the outrage: “UBS cheats target key Australian interest rate”.
The LIBOR (the London Inter Bank Offering Rate) scandal has been going on for a number of years, winding its way through multiple investigations, sackings and fines in the US, UK and Switzerland, culminating in the last few months in massive fines to Barclays, UBS and RBS. And there is more to come.
The allegations that UBS attempted to game Australia’s local rate, the Bank Bill Swap rate (BBSW), came to light this week through the release of minutes of proceedings by the Commodities Futures Trading Commission which mentioned an internal UBS inquiry.
With some notable exceptions, the Australian financial press has generally stayed aloof and generally supercilious when the LIBOR scandal is mentioned because they had been told that all was well with the BBSW.
Who told them that? Of course, the very people responsible for collecting and disseminating the BBSW rate, the Australian Financial Markets Association (AFMA), or the investment bankers’ trade union.
Until recently the British Bankers’ Association (BBA) had said exactly the same things about LIBOR and were so wrong. As a consequence, the official Wheatley inquiry into the fiddling of LIBOR rate(s) has recommended taking the publication of benchmark rates away from the BBA and giving the management to a new independent arms-length body.
Now AFMA are correct in claiming that there are structural differences between the calculation of LIBOR and the Australian BBSW, most importantly in that BBSW rates should be based on actual as opposed to estimated rates. Certainly those differences make rigging the rates more difficult - but not impossible.
The BBSW calculation process is similar to that of LIBOR. Each of 14 banks (the major Australian banks plus the usual suspects, UBS, RBS Citigroup, JPMorgan etc.) may enter rates for up to 6 maturities (1 to 6 months out). For each maturity, there is then a process of ‘topping and tailing’ whereby highest or lowest rates are removed until a maximum of six rates remain and then the average taken as the official rate.
As with LIBOR, the BBSW calculation process is designed so that no one contributor of rates can precisely fix the final rate.
But can banks influence rates and why would they want to do so?
It doesn’t take a genius to work out that by deliberately entering a high rate, the average is likely to be (but not certainly) higher than it would have been if a lower rate were entered, due to removing of outliers.
Why would banks try to influence BBSW (or LIBOR) rates upwards or downwards? Simply, because it is in their interest to do so.
The key influence in the LIBOR Scandal is the enormous growth of the global Interest Rate Swaps (IRS) market, which has contracts outstanding in the order of some $300 trillion (yes trillion) of so-called “notional amount”.
Interest Rate traders often have billions of dollars of Fixed/Floating swaps due to “reset” each week. If they can push the markets rates in a certain direction for those contracts, then they can profit when the rates are re-set.
This is precisely what happened with LIBOR. Traders attempted to influence rates when they had re-sets on their IRS positions.
How could traders ensure that they could influence the rates?
The inquiries into the manipulation of LIBOR by Barclays, UBS and RBS all show that, by using so-called “wash trades”, traders were able to compensate brokers for helping them to influence submissions at other banks. The fact that the trading community is so small means that everyone knows everyone else and has probably worked with, or for, their counterparts at other banks at some time in their career. Scratching backs becomes part of the game.
How did the traders get away with it?
The inquiry into UBS by the CFTC says it all “reviews conducted by both Compliance and Group Internal Audit did not notice the misconduct”. Why? Because no one was looking for it. Everyone had become complacent, believing the BBA hype that the calculation could not be gamed.
The final word of warning should come from Johnny Cameron, former Chairman of Global Banking and Markets RBS Group, in testimony to the UK Parliamentary Commission on Banking Standards.
Mr Cameron who had been in charge of those involved in the LIBOR scandal at RBS, was asked, “You must surely have known, then, what was going on and what their culture was, at its most general?” He replied:
“No. That is why traders need very tight, close management… Risk managers, control managers and so on and so forth completely missed the point, because everybody thought that the way LIBOR was fixed was that there are however many banks it is and the bottom quartile and the top quartile are excluded.”
The Australian financial press should not fall into the same trap. There may be (and hopefully is) nothing wrong with the process of setting BBSW rates but if there has been manipulation then there will be lots of eggs on lots of faces.