An overview of LIBOR fixing scandal and its impact on insurance. Chris Arnold Partner

Transcription

1 LIBOR fixing An overview of LIBOR fixing scandal and its impact on insurance David Chadwick Partner Chris Arnold Partner July 2012 Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe-Brussels LLP both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC ); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

2 Introduction An overview of LIBOR. The Barclays LIBOR fixing scandal. LIBOR claims: criminal/regulatory; civil. Potentially relevant insurance policies. Policy issues. What s next?

3 What is LIBOR? London Interbank Offer Rate Benchmark reference rate which underpins US$800 trillion of borrowing contracts worldwide. LIBOR and EURIBOR are the most prevalent benchmark reference rates used in Euro, US dollar and Sterling OTC interest rate derivative contracts and exchange traded interest rate contracts. The LIBOR rates determine global flows of billions of dollars each year.

4 How is LIBOR calculated? Calculated on a daily basis each contributor bank formulates their own rates and submits to Thomson Reuters and British Bankers Association. Panel consists of 18 banks. Submissions based on the following question: At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to a.m.? The submissions are based on the lowest perceived rate at which a bank could obtain funding in a reasonable market size in the London interbank money market, for a given maturity and currency.

5 How is LIBOR calculated? (cont d) Submissions made across 15 maturities (ranging from overnight to 12 months) in 10 different currencies. Top four and bottom four submissions are discarded. Remaining contributions are then averaged to create LIBOR. Submissions of all the participants are published along with each day s LIBOR fix.

6 What is LIBOR used for? (LIBOR related financial products) Floating rate corporate loans. Floating rate corporate bonds and asset-backed securities. Variable rate mortgages and consumer loans. Interest rate swaps. Cross-currency swaps. Futures and Options Contracts. Funding leg of leveraged products: total return swaps; equity derivatives; contracts for difference.

7 Application of LIBOR to certain financial products Variable rate mortgages: Some mortgages are LIBOR-linked trackers and rates are reset quarterly. Standard Variable Rate (SVR) may also be benchmarked off LIBOR rates, which may influence the SVR at periodic resets. Interest rate swaps. Fixed rate payer pays fixed rate on fixed notional amount. Floating rate payer pays 3 month LIBOR on fixed notional amount. Quarterly payments made based on difference between rates.

8 Problem with LIBOR It is subjective a banker s poll, not a statistical measure. Based on estimates, not actual prices banks have lent at. No reporting of actual rates for inter-bank lending. Single bank should not be able to influence LIBOR significantly. In times of funding stress, no bank wants to stand out from the rest. All banks might be tempted to submit artificially low LIBOR estimates to avoid being seen as risky.

9 Barclays LIBOR fixing scandal June 2012: fined a total of 290 million; US Commodity Futures Trading Commission ( CFTC ) million; US Department of Justice million; FSA million biggest fine ever (despite 30% reduction for Barclays cooperation). Barclays admitted misconduct by breaching four of FSA s Principles for Business: 1) inappropriate submissions following requests by derivative traders; 2) inappropriate submissions to avoid negative media comment; 3) systems and controls failings; 4) compliance failings.

10 Barclays LIBOR fixing scandal (cont d) In April 2008: a senior Barclays treasury manager told BBA that Barclays was not reporting accurately; a Barclays manager told the FSA that it was understating its LIBOR submissions. Evidence of Barclays manipulating LIBOR since 2005 (derivatives). CFTC investigation commenced in May CFTC enlisted FSA by Spring Possibly up to 19 other institutions under investigation by regulators on 3 continents. Falling share prices of banks. RBS sacked 4 employees in Autumn UBS and Citigroup been disciplined by Japanese regulators for manipulating TIBOR in December 2011.

11 Barclays LIBOR fixing scandal (cont d) Resignations: Marcus Agius (Chairman); Bob Diamond (CEO); Jerry del Missier (COO). SFO investigation started in July Possibility of: criminal prosecutions against Barclays employees; directors disqualification proceedings against senior directors of Barclays; OFT and/or EU Commission anti-competitive practices claims; civil claims (some already commenced in US).

12 LIBOR claims regulatory and criminal Regulatory Regulatory investigations continuing into 19 other institutions: expect further fines to be imposed in the US and UK (and possibly EU) against UK banks; RBS, Lloyds and HSBC allegedly under investigation by FSA. Anti-competitive practices Possibility of EU Commission Article 101 investigation into anti-competitive practices: ability to impose fines of up to 10% of worldwide turnover; third parties can rely on Commission s decision to base damages claims. Criminal investigations and prosecutions SFO investigation started: likely to look at conduct of requestors and submitters: Potential prosecutions under Theft Act 1968 and Fraud Act 2006 (both require dishonesty to be established). Potential criminal investigation by Office of Fair Trading into anti-competitive practices (cartels, price fixing): OFT can also bring director disqualification proceedings.

13 LIBOR claims - civil US: securities fraud class actions by persons who bought shares in Barclays and other banks none commenced yet; financial product class actions by corporates: claims by financial and non financial firms likely to be based on allegations of fraud directly related to a LIBOR linked product, e.g. false or misleading Eurodollar interest rates linked to the Eurodollar futures contracts on the Chicago Mercantile Exchange; Metzler Investment GmbH v Bank of America, Barclays, Citibank, Credit Suisse, JP Morgan, HSBC, Lloyds, WestLB, UBS, RBS, Deutsche Bank: allege violation of federal and state law; Sherman Act, Clayton Act, Securities Act 1933, SEA 1934, RICO, statutory and common law of California.

14 LIBOR claims civil (cont d) centralisation of 17 class actions in SDNY: 7 primary and 10 additional related actions centralised; share common issues: Consumer class actions. allege that the defendants manipulated LIBOR by deliberately and intentionally understating their respective borrowing costs to the BBA; in doing so, they paid lower interest rates to customers who bought the defendants products with rates of return tied to LIBOR; defendants avoided disclosing the true risk premium that the market attached to the products during the global financial crisis. Anti-trust actions: City of Baltimore v Barclays: claim for more than US$300 million arising from misselling of interest rate hedges.

15 LIBOR claims civil (cont d) UK: Potential for product litigation banks might face claims related to losses on interest rate swaps and options; Potential for claims by bond investors holding portfolios of floating rate securities claiming loss of income due to banks setting LIBOR rates artificially low; group litigation orders?; FSA Consumer Redress Schemes?; shareholder derivative actions?; Reported that private enforcement actions planned (Hausfield LLP and Edwin Co LLP) on behalf of affected parties who have suffered loss in UK or Europe

16 LIBOR claims quantum of civil claims Very difficult to quantify. One method: estimate what LIBOR would have been without manipulation and then aggregate the difference: can then be applied to bank s exposures on interest rate derivatives. End of 2011, notional amount of interest rate derivatives for three largest UK banks in the tens of trillions. Assuming just 0.05% mispricing over 4 years, this might suggest that damages could equate to 2 billion for each 1 trillion of notional interest rate derivatives.

17 Insurance impact potentially relevant policies D&O: FIPI: advance defence or investigation costs for regulatory and criminal investigations and prosecutions. indemnify director for third party liability claims if they are innocent and professional services exclusion does not apply. could respond to regulatory or criminal investigations against the bank itself; could respond to third party liability claims by customers or counterparties of the bank.

18 Insurance impact potentially relevant policies (cont d) Crime: employee infidelity?: EPL: has the bank incurred a direct loss as a result of false LIBOR submissions by the employee(s)? did employee intend to cause the bank a loss or to obtain an improper financial gain for themselves or another person?; does definition of IPG exclude salary, businesses, commissions etc? can extend to include trading and dealings in securities, commodities, futures, options, currencies, FX, loans, extensions of credit, but is fixing LIBOR trading etc? unfair or wrongful dismissal claims by sacked bank employees for their involvement in LIBOR fixing?

19 Insurance impact policy issues (general) Insurers will want to keep an eye on first awareness: activity dates as far back as 2005; 2008 CFTC investigation started; 2010 FSA investigation started; was Responsible Department aware? what enquiries were made when Proposal Form was completed? what was in the public domain that insurers should have been aware of? Notification: could the CFTC s and FSA s investigations been notified sooner? is notification requirement a condition precedent to insurers liability? what year of account should claim attach to?

20 Insurance impact policy issues (general) (cont d) Acquisition clause: has the FI been acquired recently? does policy provide pre-acquisition cover? Retroactive date keep an eye on this. Definition of Loss: often excludes fines, penalties, punitive or exemplary or multiple damages; often excludes fees, commissions or other charges paid or due to the Insured.

21 Insurance impact policy issues (general) (cont d) Professional services: does the claim arise out of the provision or failure to provide financial and/or professional services to third parties for which the bank is or allegedly is liable? is the bank providing a service to a third party by fixing LIBOR? Mitigation: Excess: Insurers may be faced with insureds looking to protect their reputation and minimise losses by proactively taking steps to compensate its customers and/or mitigate its losses; topical issues of mitigation will arise, including whether the insuring clause has been triggered and the extent of cover under any mitigation extension. can the claims be aggregated for the purpose of applying the excess? originating cause language or narrow wording?

22 Insurance impact - potential exclusions Exclusions based on motive: excludes claims from the gaining of profit or advantage to which the Insured is not legally entitled or the committing of any dishonest or fraudulent act by the Insured (final adjudication often required FSA/CFTC findings sufficient?) attribution of knowledge issues. Corporate or Business Policy was the practice of manipulating LIBOR approved by the appropriate parties to trigger this? Were they aware of the practice? Deliberate breach of laws? Market abuse: claims for market abuse under FSMA 2000 may be excluded; some market abuse exclusions are drafted more widely than FSMA definition.. RICO/SEC: conduct which amounts to a breach of RICO or SEC rules may be excluded.

23 Insurance impact - potential exclusions (cont d) Shareholder exclusion: claims by persons who purchased shares or bonds in the banks might argue that they were purchased at artificially inflated prices - keep under review; claims by shareholders regarding Bob Diamond s statements that Barclays problems were behind it. Performance guarantee exclusions: conceivable that an FI involved in LIBOR fixing on one side might be accused by a customer of effectively making false promises as to the performance of a product where the insured should be deemed to know of its own involvement in the rate fixing and the likely impact of this on the customer s investment.

24 Insurance impact - potential exclusions (cont d) Lender s liability: excludes claims arising from loans, leases or extensions of credit, except where claim arises out of a wrongful act in the administration of the loan, lease or extension of credit. Does fixing LIBOR amount to such a wrongful act? Diminution of value of investment and securities: some policies include very wide exclusions for loss arising from the diminution of value of securities/investments. Hedging transactions: exclusion of claims directly or indirectly from advice given by the Insured in connection with hedging transactions. Contractual liability?

25 LIBOR what s next? More FSA/CFTC fines against other banks? Potential regulatory action in other European and Asian jurisdictions. Criminal prosecutions or directors disqualification proceedings may be commenced (long way off). Raft of civil claims, particularly class actions in US (more difficult to launch collective actions in Europe), but demonstrating causation and quantifying losses could be fraught with difficulty. Bank v bank claims ex turpi causa.

26 David Chadwick Partner Chris Arnold Partner Tel:

27