LIBOR Manipulation Research Articles

LIBOR meets machine learning: A Lasso regression approach to detecting data irregularities

We use the Lasso linear regression technique to detect level shifts and additive outliers in both the daily 3 and 6 month US dollar LIBOR rates, and compare the results to an identical application of this technique to non-LIBOR, US short-term funding benchmarks. We find that the two LIBORs have the largest incidence of outliers, especially, additive outliers. For two non-LIBOR benchmarks, the 6 month Treasury bill and the Federal funds effective rate, no outliers were detected, which reinforces our results. Furthermore, our identified outlier episodes for both LIBOR rates fall inside the period that the manipulation of LIBOR occurred.

Beyond LIBOR: Money Markets and the Illusion of Representativeness

Money market benchmarks are important indicators for economic agents. They are also crucial for central banks in assessing the functioning of the interest rate channel of the monetary transmission mechanism. However, whereas the unsecured interbank money market conventionally has been seen as encompassing instruments with maturities up to one year, it appears as if it consists of two markets. The ultra-short-term money market (typically just one day) is large, liquid, and traded regularly. The term money market (one, three or six months), by contrast, is small, illiquid and rarely traded. This article explores the feasibility of creating and maintaining a money market benchmark which does not represent an underlying liquid market. From a sociological perspective, it addresses two critical aspects of financial benchmarks: (1) that they are related to but separate and distinct from the objects determining them and (2) that they are measurements and as such cannot be bought or sold (Stenfors and Lindo 2018). By doing so, the article also reflects upon the desire by financial regulators following the LIBOR manipulation scandal to replace estimation-based by transaction-based benchmarks, as well as some challenges and contradictions in conventional central banking theory.

LIBOR's poker

The recent LIBOR and ISDAfix manipulation scandals have inspired discussions about survey-based financial benchmarks. I investigate surveys as the statistical inference problem plagued by the principal-agent frictions between benchmark administrators and banks. Without knowing the distribution of private signals, an administrator can implement a sufficient expected quadratic penalty through random audits and post-audit fines to minimize reporting errors and induce a distribution-free expected benchmark bias. Sufficiently frequent random audits that discipline the bank with maximum borrowing cost can mitigate the impact of constraints on post-audit fines. Finally, delaying the release of bank reports may not be effective in fighting collusion.

ANTITRUST DAMAGES IN FINANCIAL MARKETS

Abstract I briefly review the standard regression methods used to estimate damages in antitrust actions, and I analyze how these would be applied to cases in financial markets. I consider applications to three different financial market cases. The first is the NASDAQ odd-eighths litigation, where existing antitrust methods closely resemble the analyses published in the academic literature on this issue. The second type of case is bond market antitrust litigation, where the expert faces an additional hurdle because they have to estimate bid-ask spreads. The third type of case is related to the LIBOR manipulation scandal. I analyzed why existing methods provide a poor fit for the LIBOR damage calculations. Lastly, I evaluate IPO issuance fees as an example of price clustering in financial markets that has not let to antitrust litigation.

Beyond LIBOR: Money Markets and the Illusion of Representativeness

Money market benchmarks are important indicators for economic agents. They are also crucial for central banks in assessing the functioning of the interest rate channel of the monetary transmission mechanism. However, whereas the unsecured interbank money market conventionally has been seen as encompassing instruments with maturities up to one year, it appears as if it consists of two markets. The ultra-short-term money market (typically just one day) is large, liquid and traded regularly. The term money market (one, three or six months), by contrast, is small, illiquid and rarely traded. This paper explores the feasibility of creating and maintaining a money market benchmark which does not represent an underlying liquid market. From a sociological perspective, it addresses two critical aspects of financial benchmarks: i) that they are related to but separate and distinct from the objects determining them and ii) that they are measurements and as such cannot be bought or sold (Stenfors and Lindo 2018). By doing so, the paper also reflects upon the desire by financial regulators following the LIBOR manipulation scandal to replace estimation-based by transaction-based benchmarks, as well as some challenges and contradictions in conventional central banking theory.

Benchmarking the World: A Proposal for Regulatory Oversight of Stock Market Index Providers

Wall Street has recently seen a shift from active management, where investors or portfolio managers buy and sell stocks, towards passive management, where investors invest in funds that seek to match the returns of an underlying index. As the popularity of index funds has grown, questions have arisen regarding the role of the index providers that produce the underlying indices. Unlike the funds themselves, these providers are currently not regulated by the U.S. Securities and Exchange Commission. This wide discretion may allow index providers to take control of the market, since they have the ability to control investors’ exposure to different countries’ markets. The role of index providers also raises concerns about investor transparency and market manipulation in the wake of the 2012 LIBOR manipulation scandal. This Note argues that the U.S. investment industry should require index providers to register with the SEC and to solicit comments from the public through notice-and-comment periods when the providers add new rules or modify existing rules.

Finance on Trial

AbstractIn the context of the recent financial meltdown, the financial industry has frequently been accused of being indifferent to the irregular practices of its members or even to be criminogenic. But how do actors of the financial industry respond to such accusations and defend themselves? How do they justify their actions when facing legal charges as well as public blame? This article elucidates these questions through a rare ethnographic case: the first criminal trial of a trader involved in the manipulation of Libor, which took place in London in 2015. Tied to at least $300 trillion contracts, Libor is a benchmark that plays a key role in the financial industry. The paper offers a sociological framework to capture the justifications of financial wrongdoings, arguing that they are structured around three elements: (a) a conception of rules; (b) a narrative; (c) a form of responsibility. I distinguish three justifications: the one of the maker, of the interpreter and of the user. I finally discuss how these justifications contribute to the general tolerance towards white-collar crime.

Amicus Curiae Brief in Gelboim v. Bank of America (Libor Manipulation Litigation) on Behalf of Financial Markets Law Professors in Support of Plaintiffs-Appellants

This amicus brief, filed with the Second Circuit Court of Appeals in Gelboim v. Bank of America (LIBOR Manipulation Litigation), primarily aims to help the Court by providing relevant background information. Many of the plaintiffs in this case are bringing antitrust claims based on defendant banks' alleged collusion while selling plaintiffs over-the-counter derivatives. To evaluate these plaintiffs’ allegations, one must understand the nature of these derivative transactions, the economics of the over-the-counter derivatives market, and the specific role that the London Interbank Offer Rate (“LIBOR”) plays in that market. This brief provides that information. With this background in place, it becomes clear that these plaintiffs have properly alleged an antitrust injury. Plaintiffs allege that defendants, who controlled the over-the-counter derivatives market, conspired to manipulate LIBOR in order to increase their profits in the over-the-counter derivatives market. Plaintiffs allege that they, in their capacity as defendants’ customers in the over-the-counter derivatives market, suffered an injury as a result of defendants’ collusive LIBOR-setting behavior. Taking plaintiffs’ allegations as true, this is a classic antitrust injury.Accordingly, this court should reverse the district court’s opinion and remand for further proceedings.

Order Flow Toxicity and Informed Trading around Known Market Manipulation Events: Evidence from Interest Rate Futures

The objective of this paper is an ex-post review of the effectiveness of PIN and VPIN in determining changes in the information structure and order flow of a futures market around documented episodes of recorded manipulation of the reference rate, from the various publicly available regulatory reports. In keeping with previous studies on interest rate derivatives, this analysis finds that the average PIN is far higher for futures than for the equity market at or above 60%. Furthermore, I find a very strong connection between PIN, VPIN and time to maturity of the contract that is not fully explained by the time variation in activity in the market. However, an event study using both a new bootstrap approach and asymptotic standard error on the VPIN and PIN respectively around documented LIBOR manipulation cases has mixed results. For certain events I see a substantial change in the average detected levels of PIN and VPIN, however a cross sectional analysis of all reported cases up to mid-2015, indicates no significant change in the PIN and VPIN for the contracts in this Eurodollar sample.

The manipulation of LIBOR and related interest rates

Purpose – The “London InterBank Offered Rate” (LIBOR) is one of the most important short-term interest rates with trillions of US dollar in financial products tied to it. Due to recent allegations of manipulation of the LIBOR, this paper aims to investigate the integrity of this rate. Design/methodology/approach – The paper analyzes the LIBOR and its rate fixing process using different screens to detect potential manipulative behavior on the macro and micro level. As main frameworks, an interest rate parity approach and the construction of a theoretical LIBOR using Credit Default Swap (CDSs) are applied. A simulation on the potential impact from one through four banks manipulating the LIBOR is performed as well. Findings – The results on the macro level show that the LIBOR deviates heavily from other short-term interest rates from mid-2007 onwards, reaching its peak in September 2008 with the collapse of Lehman Brothers. On the micro level, the individual submissions of the panel banks are investigated, finding inconsistencies for Barclays and HSBC. Furthermore, a simulation on the influence from potential manipulation under the current calculation method reveals substantial effects on the LIBOR fixing. Even one bank trying to manipulate the fixing has a strong influence on the rate setting. Originality/value – This paper contributes to the academic landscape in that it investigates the LIBOR rate setting process and if irregular behavior can be detected, given the screens used. Due to the findings of conspicuous behavior in the fixing during certain periods, the integrity of the rate setting process is more than questionable.

Forecasting the LIBOR‐Federal Funds Rate Spread During and After the Financial Crisis

In this paper, we examine the point and density forecast accuracy of econometric models, surveys and futures rates in predicting the LIBOR‐Federal Funds Rate (LIBOR‐FF) spread during and after the financial crisis. We provide evidence that the futures market forecast outperforms all competing forecasts during and after the financial crisis and that its predictive density is well calibrated. Our results also suggest that the predictive accuracy of the econometric models improves in the post‐crisis period. We argue that the post‐2009 improvement in the econometric models' forecasts is attributable to the absence of LIBOR manipulation. The economic significance of the uncovered predictability is assessed using a trading strategy. Our results suggest that trading based on the futures market and econometric forecasts generates positive risk‐adjusted returns. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 36:345–374, 2016

Reforming LIBOR and Other Financial Market Benchmarks

LIBOR is the London Interbank Offered Rate: a measure of the interest rate at which large banks can borrow from one another on an unsecured basis. LIBOR is often used as a benchmark rate— meaning that the interest rates that consumers and businesses pay on trillions of dollars in loans adjust up and down contractually based on movements in LIBOR. Investors also rely on the difference between LIBOR and various risk-free interest rates as a gauge of stress in the banking system. Benchmarks such as LIBOR therefore play a central role in modern financial markets. Thus, news reports in 2008 revealing widespread manipulation of LIBOR threatened the integrity of this benchmark and lowered trust in financial markets. We begin with a discussion of the economic role of benchmarks in reducing market frictions. We explain how manipulation occurs in practice, and illustrate how benchmark definitions and fixing methods can mitigate manipulation. We then turn to an overall policy approach for reducing the susceptibility of LIBOR to manipulation before focusing on the practical problem of how to make an orderly transition to alternative reference rates without raising undue legal risks.

Too LIBOR, Too Late: Time to Move to a Market Rate

Barclays has been fined, the British have issued their report, and now the market is anxious for everything to go on as usual with the London Interbank Offer Rate (“LIBOR”). I think that would be a serious mistake. The U.S. and British investigations into rate-fixing by Barclays revealed a widespread culture of pervasive, deceitful conduct in the setting of the most important private sector benchmark for over $300 trillion in derivative contracts and $10 trillion in adjustable-rate loans. It is highly unlikely that Barclays was the only major bank engaging in this conduct, and public investigations and private lawsuits against a range of participants in LIBOR rate-setting are likely to reveal further misconduct in the months ahead. The basic structure for the setting of LIBOR is fundamentally flawed. It permits banks with obvious conflicts of interest to skew the LIBOR rate in order to benefit their own firm. Barclays, for example, was alleged to have attempted to manipulate LIBOR to benefit its traders and to hide its growing costs of borrowing in the financial crisis. The LIBOR structure also facilitates collusion among the rate-setting banks, in violation of the antitrust laws. Barclays, for example, was alleged to have attempted to manipulate LIBOR in collusion with other firms to benefit particular trades over a number of years. Both public antitrust investigations and a range of private lawsuits are likely to be pursued with vigor in the coming months. The collusion and manipulation were alleged to have occurred during both quiescent markets and turbulent ones. That is, the attempted manipulation of LIBOR was apparently not confined to one extraordinary “once-in-a-lifetime” financial crisis, when extreme market pressures might have lured firms to engage in this unlawful conduct, but rather was ingrained in the regular setting of rates. As it currently stands, LIBOR is not a market interest rate. It provides the illusion of market rates that are relied upon by everyone from sophisticated derivative traders to ordinary mortgage borrowers, but the rate itself is pure fiction. Banks submit a rate at which they supposedly could borrow, but there’s no requirement that the rates submitted be based on actual transactions. As Mervyn King, Governor of the Bank of England put it, LIBOR represents “the rate at which banks do not lend to each other.”

Reforming LIBOR and Other Financial-Market Benchmarks

LIBOR is the London Interbank Offered Rate: a measure of the interest rate at which large banks can borrow from one another on an unsecured basis. LIBOR is often used as a benchmark rate�meaning that the interest rates that consumers and businesses pay on trillions of dollars in loans adjust up and down contractually based on movements in LIBOR. Investors also rely on the difference between LIBOR and various risk-free interest rates as a gauge of stress in the banking system. Benchmarks such as LIBOR therefore play a central role in modern financial markets. Thus, news reports in 2008 revealing widespread manipulation of LIBOR threatened the integrity of this benchmark and lowered trust in financial markets. We begin with a discussion of the economic role of benchmarks in reducing market frictions. We explain how manipulation occurs in practice, and illustrate how benchmark definitions and fixing methods can mitigate manipulation. We then turn to an overall policy approach for reducing the susceptibility of LIBOR to manipulation before focusing on the practical problem of how to make an orderly transition to alternative reference rates without raising undue legal risks

Statistical evidence about LIBOR manipulation: A “Sherlock Holmes” investigation

This paper contributes to the crucial problem of LIBOR malfunctioning due to its manipulation by banks, a phenomenon described clearly in the FSA Inquiry Report published in September 2012. After applying classical tests of non-stationarity to a series of participating banks’ LIBOR quotes, we detected some significant breaks in the data that correspond to significant economic events, namely Lehman Brothers’ bankruptcy or central banks’ decisions. Our conclusion is that a possible manipulation, confirmed ex post in the FSA report, can be deduced throughout the crisis period as a result of the behavior of the coefficients in a linear three-regime Threshold Regression model. Finally, we applied an original procedure to detect those banks most likely to build cartels – or at least homogeneous groups – during the important period of turmoil under review, namely August 2007 through November 2012. This method, called hierarchical clustering analysis, helped us to precise the conclusions of the abovementioned FSA inquiry.

LIBOR manipulation: operational risks resulting from brokers’ misbehavior

Brokers perform a key role in many financial markets. They introduce buyers to sellers, perform a useful role in price-discovery and provide a source of market information and commentary to market participants and the general public. In well-organized markets, brokers are trusted to be honest and to undertake these tasks in the best interests of their clients (buyers or sellers). But there is an inherent and well-understood conflict of interest in the role of the broker. Brokers are rewarded by their success in bringing buyers and sellers together, but their source of income is based solely on the completion of a successful transaction. Hence, there is a constant temptation for a broker to trade the best interests of their client for a completed deal. This paper examines the key role of brokers in the LIBOR manipulation scandal and using reports from published inquiries identifies the illicit activities of some brokers in assisting banks to manipulate the LIBOR benchmark. The perpetrators of these "white collar" crimes were traders and managers in some of the largest banks in the world but the manipulation would not have been as widespread or as successful without the willing participation and illegal actions of brokers in several firms. The paper argues that the actions of the traders in various banks around the world in the LIBOR manipulation scandal are examples of systemic operational risk, and in particular people risk. The paper makes specific suggestions to bank boards and regulators as to how such misconduct may be managed in future.

Roundtable on Ex Officio Cartel Investigations and the Use of Screens to Detect Cartels

Despite the successes of cartel detection over the last twenty years, there are many who believe that competition authorities have just started to scratch the surface. The focus of this note is to make the case that proactive detection and deterrence policies need to be established, and that those policies should be led by the use of empirical screens. Though screens have gained significant popularity and adoption over the last five to eight years, with a track record including successes such as the flagging of the LIBOR conspiracy and manipulation, some competition authorities are still reluctant to adopt these empirical tools. Concerns often relate to “too many resources are required” or “lack of robustness” of current screens, or simply “screens don’t work,” among others discussed later in this note. In my view, these arguments against screens though understandable are misplaced, and this notes addresses in detail my counterarguments. As I hope this note will make clear, the effectiveness of screens should, by now, largely be beyond dispute. Can screens flag illegal behavior or not? And have they already done so? Yes they can, and yes they have already flagged large scale matters multiple times, such as on LIBOR which is perhaps the largest conspiracy and manipulation of its type ever uncovered, but I do not expect it to be the last.

Financial Market Misconduct and Public Enforcement: The Case of Libor Manipulation

Using comprehensive data on London Interbank Offer Rate (Libor) submissions from 2001 through 2012, we provide evidence consistent with banks manipulating Libor to profit from Libor-related positions and to signal their creditworthiness during distressed times. Evidence of manipulation is stronger for banks that were eventually sanctioned by regulators and disappears for all banks in the aftermath of the Libor investigations that began in 2010. Our findings suggest that the threat of large penalties and the loss of reputation that accompany public enforcement can be effective in deterring financial market misconduct. This paper was accepted by Adams, Renee, finance.

The LIBOR Scandal - It's Not Over Yet

The manipulation of LIBOR rates was not a localized event. Unscrupulous traders and managers in some of the largest banks around the world deliberately and systematically manipulated borrowing rates. It was not the work of isolated 'rogue traders' but part of business-as-usual in the international money markets. This presentation describes the LIBOR Scandal and argues that it is an example of Systemic Operational Risk, in particular People Risk. T The paper then looks at official inquiries into manipulation of LIBOR at three banks: Barclays, UBS and RBS to identify examples of Operational Risk. The transcripts of conversations unearthed by these investigations show rampant illicit activities that were apparently a normal part of doing business, as traders, LIBOR submitters and brokers colluded to manipulate LIBOR for their own interests. Finally, the paper makes some suggestions as to how the management of Systemic Operational Risks may be addressed by banks and regulators.

Proactive vs Reactive Anti-Cartel Policy: The Role of Empirical Screens

Despite the successes of the last twenty years in cartel detection, there are many who believe that competition authorities have just started to scratch the surface. The focus of this paper is to make the case that proactive detection and deterrence policies need to be put in place worldwide, led by the use of empirical screens. Combining screens with more aggressive corporate compliance programs, whistleblower programs, general business community education and guidelines on collaborations which are likely to be anticompetitive, leniency programs will be supplemented and enhanced and anti-cartel policy will become more effective around the world. Screens can play a critical role in cartel detection and also in deterring cartel formation. Their recent significant successes such as the flagging of the LIBOR conspiracy and manipulation can attest to their power and potential as proactive anti-cartel detection tools around the world. There have always been those who are naturally skeptical that simple empirical analyses can be brought to bear in complex markets. Hopefully, the LIBOR scandal will settle the question of whether screens should be more vigorously applied and move the discussion to how that needs to happen.