The Libor Scandal: Another Example of Neutralised and Routinised Deviance in the Financial Services Sector?

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In recent times there have been a number of analyses posted on the CLMR portal about the London Inter-Bank Offered Rate (Libor) scandal, for example by Armour, Lynch and O’Brien.  These opinion pieces discuss a range of issues that the Libor case study highlights, including: the structural weaknesses of self-regulation; reputational risk; the prevalence of market manipulation with its subsequent implications for the relative efficacy of prevailing compliance systems; and the prospects of the LIBOR scandal being repeated in other jurisdictions.  This paper considers some of the key regulatory reactions thus far to the Libor scandal in the UK and elsewhere.

First a reminder of what Libor is, why it is so significant and what prompted the current scandal.  Libor, which is administered by the British Bankers Association (BBA) and published daily by Thomson Reuters at 11:30 (Greenwich Mean Time), is a basket of interest rate benchmarks that are calculated on a daily basis across ten currencies and fifteen different time periods, (from overnight to one year), based on daily submissions from panels drawn from Libor’s member banks.  There are more than two hundred member banks which provide input to the various panels, so for example the current panel for the US$Libor has eighteen banks from different countries around the world (including most notoriously, so far at least, Barclays Bank).  These rates are intended to provide a set of meaningful average costs that banks face for unsecured borrowing for a given currency over a specified period.  Thus, the Wheatley Review, (itself an official response by the UK Chancellor of the Exchequer to the Libor scandal), notes that: “Libor is the most frequently utilised benchmark for interest rates globally, referenced in transactions with a notional outstanding value of at least $300 trillion”. The enormous international strategic significance of Libor was emphasised in another, (non-UK), regulatory response – the announcement of the establishment of the International Organisation of Securities Commissions (IOSCO) Task Force on Financial Market Benchmarks (The IOSCO Task Force), when its Co-chair, Mr Gary Gensler, Chairman of the US Commodity Futures Trading Commission (CFTC) stated: “When people save money in a money market fund or short term bond fund, or take out a mortgage for a home or a small business loan, the rate they receive or pay is often based, directly, or indirectly, on Libor.”  So, it should be clear that reliance on the veracity of the Libor benchmarks is one of the integral fulcra of the contemporary global financial system, as it is perhaps the primary benchmark for short term interest rates globally.  As the Wheatley Review itself notes Libor: “..was established in the 1980s in order to provide a fair and standardised interest rate benchmark for loans, thereby facilitating the growth of the syndicated loans market.”

Perhaps the most important word used in the last quote is fair, because it is this assumption of fairness regarding Libor which explains why there has been so much outrage about manipulation of Libor by one of the UK’s most significant banks Barclays.  In its high profile Order of 27 June 2012 which filed and settled charges against Barclays, the CFTC found that since at least 2005, Barclays PLC, Barclays Bank and Barclays Capital: “..repeatedly attempted to manipulate and made false, misleading or knowingly inaccurate submissions concerning two global benchmark interest rates…Libor…and the Euro Interbank Offered Rate (Euribor).”  The CFTC Order required Barclays to pay a $200 million civil penalty, cease and desist from further violations, improve its internal controls and ensure the integrity and reliability of its future Libor and Euribor submissions.  Also on 27 June 2012, after agreeing with the US Department of Justice (DOJ) that manipulation of submissions affected the Libor rates on some occasions, Barclays agreed to pay a DOJ penalty of $160 million.  Again on 27 June, but this time in the UK, the Financial Services Authority (FSA) fined Barclays £59.5 million for its misconduct relating to Libor.

These are substantial amounts, but they are unlikely to seriously hamper Barclays, because despite the damage wrought to its balance sheet by the Global Financial Crisis (GFC) and the fallout from sovereign debt crises in Europe, for the year 2011 Barclays was still able to report a profit of almost £6 billion.  These figures prompt public anger, especially when combined with earlier headlines such as the one that revealed that in 2009 when it made record annual profits of £11.6 billion, (and of course was manipulating the Libor), Barclays only paid £113 million in corporation tax in the UK.  Most other global banks in the UK and elsewhere have received similar criticism for their huge profits, especially following the GFC-induced public bailouts of banks in the UK, the US and other jurisdictions.  Barclays’ peers have not been castigated for manipulating Libor, although it may only be a matter of time before similar behaviour by other banks is revealed publicly.  So, currently banks globally are largely held in low public esteem and so when a scandal such as Libor emerges a bank such as Barclays has a very shallow reservoir of public goodwill on which to draw.

There have been a multitude of critical media headlines in the UK, the US and elsewhere castigating Barclays over its manipulation of Libor, but in terms of regulatory or government actor criticism, perhaps the most damning and virulent has come from the House of Commons Treasury Select Committee (Select Committee).  The Select Committee is withering in its critique of how the FSA and the Bank of England were largely ineffectual over a prolonged period in terms of Barclays’ Libor activities.  The Select Committee’s recommendations include considering whether the definition of market abuse should be widened to include manipulation such as occurred with Libor and that this be classified as a criminal offence under section 397 of the Financial Services and Markets Act.  The Select Committee is also critical of the narrow interpretation that the FSA has taken in terms of its power to initiate criminal proceedings: “The FSA’s decision whether to initiate a criminal prosecution should not be influenced by the fact that its income is derived from firms which it regulates…Financial crime is defined in section 6(3) as including not only misconduct in relation to a financial market but also any criminal offence of fraud or dishonesty.”  The Select Committee recommends that following the Wheatley Review the Government should clarify the scope of the FSA and its successors’ power to initiate criminal proceedings.

That the Select Committee should be critical of regulatory actors such as the FSA and the Bank of England and their relationship with a prominent City of London finance institution like Barclays, as well as actively canvassing the possibility of increased criminal prosecution of poor behaviour in the finance sector, shows that it is much more on the front foot than some of its predecessors.  A revealing historical insight into the hegemony, and the power and relative autonomy of the City of London was provided with the passage of Leeman's Act 1867 which sought to stop the widespread practice of not recording transactions individually, (but instead recording them as house transactions), and which also aimed to reduce speculative dealing in banking securities, (sound familiar?).  The disregard of the City even for existing statutory controls, is clear in the evidence given in 1875 by Mr. Samuel Herman de Zoete, the then chairman of the London Stock Exchange to a parliamentary committee: "Sirs, we disregarded for years Sir John Barnard`s Act and we are now disregarding in the same measure Mr. Leeman`s Act."

It is difficult to imagine any other business interest group openly defying a parliamentary committee and statutory instruments in such a manner, but it indicates the confidence of a disparate arrangement of groups and individuals in the City of London with shared economic interests in being able to tailor the discourse that constructs the regulation of their activities.  A key explanatory factor for this is that the City has been tremendously successful in having its own interests widely identified as converging with the public interest on matters of financial regulation.  This ability to shape perceptions of what entails the public interest has interacted with broader legal developments to influence significantly London's financial markets and their regulation, and these traditions have been exported to a significant degree to other finance centre such as New York.  Like other powerful actors, the City has been able to set goals for the general interests of society.  The utility that its regulatory authority has held for the diverse interests that constitute the City is the fact that its cultural norms and values were for many years adopted as conventional working practice in the UK financial sector.  Constellations of interests in the City have been successful in projecting their preferred model of financial regulation and routinised social and business practices as the natural social and economic order, thereby ensuring its hegemony.

Similar processes are at work today in London and in other finance centres around the world, in the management of conflicts and with regard to many other issues.  We should not be too surprised by this because regulation can be viewed as a commodity, a raw material which is subject to market forces and may be facilitative, inherently contradictory, manipulative and complex.  The twin pressures of special interest groups and market forces remain extremely influential in shaping contemporary regulatory praxis in financial services in the UK and elsewhere, just as they have done for centuries.  In a market society much power lies with capital resources and those involved with the raising, organisation and marketing of capital have great influence.  Also, the complexity of the financial services industry excludes most people from being able to specifically evaluate its processes, and it is within this paradigm that the Libor scandal should be understood.

Notions and practices of recurring routinisation and neutralisation of deviance are well-entrenched in the finance sector, as they are in some other industries, for example real estate, with its seemingly perennial problems of transparency and accountability in pricing and sales campaigns.  The manipulation evident in Barclays’ role in the manipulation of Libor is likely to be an example of routinised and normalised deviance in the industry and it may simply be that similar behaviour by competitors to Barclays in the UK and elsewhere simply has not yet been exposed publicly.  Certainly the Executive Committee of Barclays seems to think so.  On 15 July 2012 they distributed a memo entitled Restoring our reputation, building our business to all Barclays employees.  In that memo which is co-signed by outgoing Barclays Chairman Marcus Agius, the Committee state: “As other banks settle with authorities, and their details become public, and various governments’ inquiries shed more light, our situation will eventually be put into perspective.” Barclays have declined to make public comment on the memo but it seems only a matter of time before manipulation of Libor is revealed as practice that has been routinised and neutralised within the financial services sector.  Whether ongoing and future inquiries will reveal when, and just how much, regulatory actors knew of the manipulation of Libor one can only speculate.  Indeed it should be a moot point for such inquiries to posit to relevant regulators in home jurisdictions and overseas whether they viewed such manipulation as normalised and therefore not deviant?

Obviously there may be territorial and jurisdictional implications raised by the last point, but increasingly multi-lateral regulatory implications are impinging upon national regulatory initiatives in the financial sector, (see for example Gilligan’s recent CLMR piece on CFTC proposals regarding OTC derivatives).  Similarly, in a quid pro quo context, national priorities are impacting upon multi-lateral regulatory initiatives (see for example Gilligan’s recent CLMR piece on IOSCO’s regulatory proposal for money market funds).  It is within this context of general ongoing regulatory tension and competition, as well as the effects of unfinished business in terms of investigating routinised and normalised manipulation of Libor, that the IOSCO Taskforce begins its work.  It will be assuming the lead international role to: identify benchmark-related issues; define relevant benchmarks; identify policy issues such as appropriate regulatory oversight of benchmarking, robust processes for benchmark calculation, credible governance structures and ensuring transparency; and developing global policy guidance and principles.  Now, that is what one calls an interesting regulatory challenge!

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