Despite widespread outrage sweeping the financial industry after revelations Barclays was involved in fixing key lending benchmarks, institutional investors seeking to recoup losses face an almighty challenge.
US and UK regulators have fined Barclays more than US$450 million for manipulating the rates banks borrow unsecured interbank funds – the London interbank offered rate (LIBOR) and the euro interbank offered rate (EURIBOR) between 2005 and 2007.
Traders on the derivatives desks at Barclays were found to be colluding with those responsible for submitting the bank’s EURIBOR and LIBOR positions to benefit their own trades. Other LIBOR-setting banks are also under investigation for similar offences.
Since the benchmarks form the reference rate used for a multitude of derivatives –including the US$504 trillion interest rate swap market, forward rate agreements and inflation swaps – buy-side firms could find the rate they paid on some contracts was inaccurate.
Mountain to climb
Money managers could claim compensation for a breach of the ISDA Master Agreement, the framework governing OTC derivatives contracts developed by the International Swaps and Derivatives Association (ISDA). The ISDA agreement lets firms seek the early termination of deals if positions were distorted, such as through the manipulation of LIBOR.
But a mammoth task faces institutional investors if they are to be successful in any class action or group litigation proceedings.
“To the extent that any bank may have profited from manipulation, it will by definition have been at the expense of other participants in the market. But identifying who – and by how much – is at this stage extremely difficult,” read a statement from UK buy-side trade body the Investment Management Association.
The buy-side’s ability to claim compensation will largely depend on the sophistication of the firm involved, explained Steve Wood, founder of Global Buy-Side Trading Consultants, and former global head of trading at Schroder Investment Management.
“Many transactions that have a LIBOR element to them usually have an added mark-up,” Wood explained. “If the total is not expressed as a consolidated rate, it will be impossible for the buy-side to determine whether they were disadvantaged when entering into some structured product trades with their brokers.”
He added that while ISDA Master Agreements form the basis of many transactions, they are frequently modified, particularly by smaller buy-side firms that use ‘free-form’ agreements for each swap they enter into. By comparison, larger buy-side firms typically have a global agreement that covers transactions for each subsidiary of a counterparty it deals with.
Speaking in the Q2 issue of The TRADE, Terence Nahar, investment director in the financial solutions group of Scottish Widows Investment Partnership, noted that the market is moving to more standardised terms, citing the recently released draft credit support annex framework. “This is the latest sign the market is moving towards more standardised collateralisation agreements for non-centrally cleared derivatives,” he said.
Burden of proof
Barclays is not expected to be the only major bank involved in attempts to manipulate lending rate benchmarks, with the UK Financial Services Authority’s director of enforcement Tracey McDermott, stating that the agency “continues to pursue a number of other significant cross-border investigations in this area”.
This will make trying to prove to what extent the LIBOR/EURIBOR benchmarks disadvantaged derivatives exposures held by the buy-side a data intensive task. Indeed many money mangers may find that after analysing the data, they actually profited from the banks’ misdemeanours.
There is also the danger of souring longstanding relationships between institutional investors and brokers. This may not be in the buy-side’s interest, particularly during a time of regulatory upheaval during which it will rely on brokers to comply with sweeping changes to derivatives markets.
Furthermore, with at least the top 20 law firms already representing investment banks, buy-side firms may have to seek specialist representation to avoid conflicts of interest.
But the furore surrounding the incident could be the last straw for some investors.
“We have yet another episode that demonstrates the disconnect between what most of us think is reasonable and decent behaviour and that which has taken place at the banks,” commented Stephen Peak, director of pan-European equities at Henderson Global Investors. “Class actions are in theory considerable given that the LIBOR market is many hundreds of trillions. However, our guess at this stage is that it will prove challenging for claimants to be meaningfully successful.”
A research report from Brad Hintz, senior analyst at Sanford Bernstein, noted that class action litigation in the US is already beginning to take shape.
“As the regulatory cases against other banks become public Bernstein would expect the claims against Barclays and potentially other banks to grow significantly as the size of the alleged manipulation becomes public and the number of aggrieved parties grow. Class action civil claims typically are settled four or more years after they are filed,” read the report.