The Manipulation Potential of Libor and Euribor

AuthorMarti G. Subrahmanyam,Alexander Eisl,Rainer Jankowitsch
Date01 September 2017
Publication Date01 September 2017
DOIhttp://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 nancial
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 nd that such alternative xings
could signicantly 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, 604647
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 nancial 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 nancial
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 nancial 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 BankersAssociation
(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 nancial 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 xings), 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 nancial benchmarks, ning
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 nal rate. In line with the argument of
Kyle and Viswanathan (2008), we dene 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-xing 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 conated in the heat of the discussion. The rst 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 denition 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, inuence the computation of the trimmed mean used to set the rate. The rst 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 reects, 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
reect this variation. The second is the variation in the liquidity positions of the banks in
the panel, which reect their need for additional funding. If some banks are ush 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) dene manipulation as any trading strategy that reduces price
efciency or market liquidity.
4
In 2014, the Market Participants Group on Reforming Interest Rate Benchmarks lead by
Darrell Dufe submitted its nal 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

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