The Manipulation Potential of Libor and Euribor

• Date: 01 September 2017
• Published date: 01 September 2017
• DOI: http://doi.org/10.1111/eufm.12126

The Manipulation Potential of Libor

and Euribor

Alexander Eisl

WU (Vienna University of Economics and Business), Department of Finance, Accounting and

Statistics, Welthandelsplatz 1, 1020 Vienna, Austria

E-mail: alexander.eisl@wu.ac.at

Rainer Jankowitsch

WU (Vienna University of Economics and Business), Department of Finance, Accounting and

Statistics, Welthandelsplatz 1, 1020 Vienna, Austria

E-mail: rainer.jankowitsch@wu.ac.at

Marti G. Subrahmanyam

New York University, Stern School of Business, Department of Finance, 44 West Fourth Street, Room

9-68, New York, NY 10012

E-mail: msubrahm@stern.nyu.edu

Abstract

The London Interbank Offered Rate (Libor) and the Euro Interbank Offered Rate

(Euribor) are two key benchmark interest rates used in a plethora of financial

contracts. The integrity of the rate-setting processes has been under intense

scrutiny since 2007. We analyse Libor and Euribor submissions by the individual

banks and shed light on the underlying manipulation potential for the actual and

several alternative rate-setting procedures. We find that such alternative fixings

could significantly reduce the effect of manipulation. We also explore related

issues such as the sample size and the particular questions asked of the banks in the

rate-setting process.

This paper was previously distributed under the title ‘Are Interest Rate Fixings Fixed? An

Analysis of Libor and Euribor’. We thankfully acknowledge financial support from Inquire

Europe. We are grateful to the Editor, John Doukas, and two anonymous referees for their

helpful comments on prior drafts. We thank Viral Acharya, Stefan Bogner, Rohit Deo,

Michiel De Pooter, Darrell Duffie, Jeff Gerlach, Alois Geyer, Kurt Hornik, Jan Jindra,

Stefan Pichler, Anthony Saunders, Joel Shapiro, James Vickery, participants at the 2013

FMA Meeting, the 20th Annual Global Finance Conference, the 75th International Atlantic

Economic Conference, the 22

nd

Annual Meeting of the European Financial Management

Association, the 7th Meielisalp Rmetrics Workshop, and the Marie Curie ITN Conference

on Financial Risk Management & Risk Reporting, as well as seminar participants at the

Bombay Stock Exchange Institute, New York University, Waseda University, and SAC

Capital Advisors, for useful comments and suggestions.

European Financial Management, Vol. 23, No. 4, 2017, 604–647

doi: 10.1111/eufm.12126

© 2017 John Wiley & Sons, Ltd.

Keywords: money markets, Libor, Euribor, manipulation, collusion

JEL classification: G01,G14,G18

1. Introduction

One of the most important developments during the depths of the global financial crisis

following the collapse of Lehman Brothers on 15 September 2008 was the discussion of

the possible manipulation of the London Interbank Offered Rate (Libor) and its financial

cousin, the Euro Interbank Offered Rate (Euribor), two key market benchmark interest

rates. Although there had been prior conjectures of this possibility, new reports received

heightened attention against the backdrop of jittery financial markets following the

Lehman bankruptcy. Since spot and derivatives contracts with notional amounts running

into the hundreds of trillions of dollars are linked to Libor and related benchmarks, any

serious questions about the integrity of these rates could potentially cause massive chaos

in global markets (see, e.g., the discussion in Wheatley, 2012b).

Given the nervousness in the market at the time, the British Bankers’Association

(BBA) and the Bank of England (BoE) tried to reassure the market about the integrity of

the rate-setting process. Although the attention of market participants shifted elsewhere

for a while, there were persistent rumors, and even press reports, about the investigation,

and possible prosecution, of the panel banks that submitted quotes to the BBA. The

matter resurfaced in the financial headlines in the summer of 2012, when the

Commodities and Futures Trading Commission (CFTC), the futures markets regulator in

the United States, announced that it was imposing a US$200 million penalty on Barclays

Bank plc for attempted manipulation of, and false reporting concerning, Libor and

Euribor benchmark interest rates, from as early as 2005.

1

As part of the non-prosecution

agreement between the US Department of Justice and Barclays, communications

between individual traders and rate submitters were made public, providing evidence of

the manipulation of the reference rates on particular days. The results of an independent

review led by Martin Wheatley, discussing potential changes to the Libor benchmark

rates at a general level, were presented in the UK in September 2012. Investigations in

different jurisdictions, some of which started in 2009, are still ongoing.

In this paper, we analyse the individual submissions of the panel banks for the

calculations of the respective benchmark rates (the ‘fixings’), in detail, for the time

period January 2005 to December 2012.

2

In particular, we explore the statistical

properties of these contributions and discuss the potential effect of manipulation by panel

1

In December 2012, UBS AG also settled for a substantial penalty of US$1.5 billion as a

consequence of its role in manipulating global benchmark interest rates. More recently,

Rabobank has agreed to a US$1 billion settlement and RBS to total payments of more than

US$612 million. In addition, Barclays and Deutsche Bank face private law suits, and several

bankers involved in the scandal have faced criminal charges. Several banks have admitted to

wrongdoing regarding Yen Libor, and the European Union antitrust commission has initiated

proceedings against several banks for collusion to manipulate financial benchmarks, fining

six leading institutions US$2.3 billion in December 2013.

2

The choice of the end date is dictated by changes in the procedure implemented as a

consequence of the Wheatley report in 2013.

© 2017 John Wiley & Sons, Ltd.

The Manipulation Potential of Libor and Euribor 605

members, quantifying their possible impact on the final rate. In line with the argument of

Kyle and Viswanathan (2008), we define manipulation to be any submission that differs

from an honest and truthful answer to the question asked of the panel banks.

3

Furthermore, we explicitly take into account the possibility of collusion between several

market participants. Our setup allows us to quantify such effects for the actual rate-

setting process in place during our sample period, and compare it to several alternative

rate-fixing procedures. Moreover, we can determine the effect of the panel size on

manipulation outcomes. These results allow us to comment on important details of the

rate-setting process, as well as on broader questions, such as the use of actual transaction

data as an alternative information source.

A dispassionate appraisal of the events of the past few years and the discussion among

market professionals, journalists and regulators suggests that two conceptually distinct

issues became conflated in the heat of the discussion. The first relates to the potential

for manipulation of Libor and Euribor –which are both determined by similar

methodologies, but subject to the supervision of different bodies –under the current

method of eliciting quotes from a given panel of banks. This issue naturally leads to a

discussion of how the effect of manipulation might be mitigated, if not eliminated, by the

use of an alternative definition of the rate, without altering the method of collecting the

basic data from the panel of banks. The second and logically separate issue relates to

changing the nature of the data themselves, for example, by only collecting data on

actual transactions rather than using submitted quotes and, thus, introducing greater

transparency and reliability into the process. The latter would be a much more

fundamental change, and raises additional questions about how the liquidity of the rates

for different maturities and currencies would be affected under the restriction of being

based on transactions data.

4

Within the context of the current rate-setting process, there are three factors that

potentially affect the cross-sectional and time-series variation in the submissions, which,

in turn, influence the computation of the trimmed mean used to set the rate. The first is the

variation in the credit quality of the banks represented by the panel. Depending on the

particular question asked of the panel banks, the rate submitted by a bank reflects, to a

certain degree, the credit risk premium built into the borrowing rates.

5

If the banks have

very different credit qualities in the judgement of the market, the rates submitted could

reflect this variation. The second is the variation in the liquidity positions of the banks in

the panel, which reflect their need for additional funding. If some banks are flush with

funds of a given maturity in a currency, while others are starved of them, the rates they

submit for this currency/maturity should be very different, even if their credit standings

are similar. The third is due to the potential manipulation of the rates, as has been alleged

and even demonstrated in at least some cases, by regulatory and legal action. Since it is

impossible to disentangle the effect of manipulation from the credit risk and liquidity

effects, without detailed data on the other two effects, we address questions based solely

3

Kyle and Viswanathan (2008) define manipulation as any trading strategy that reduces price

efficiency or market liquidity.

4

In 2014, the Market Participants Group on Reforming Interest Rate Benchmarks lead by

Darrell Duffie submitted its final report discussing various of these issues, see Market

Participants Group on Reforming Interest Rate Benchmarks (2014).

5

See section 2 for details of the underlying questions used in the rate-setting process.

© 2017 John Wiley & Sons, Ltd.

606 Alexander Eisl, Rainer Jankowitsch and Marti G. Subrahmanyam