Last week we posted a note from Morgan Stanley analysts, who tried to guess at the final ultimate cost of the Libor scandal to banks — a combination of expected regulatory fines, litigation outcomes, and the business uncertainty caused by the mess.
A note from Nomura, which we’ve just posted in the usual place, arrives at a more open-ended conclusion while doing the kind of Libor vs Libor-proxy comparison that we’ve come across now and again (in this case the proxy was the Federal funds effective rate plus each bank’s one-year CDS).
Both notes were heavily caveated and we agree that it’s far too early for these kinds of exercises to produce useful estimates. For those of you waiting on a number, we may as well kill the suspense and jump straight to Nomura’s conclusion:
Estimating ultimate exposure for the LIBOR issue is thorny at best, and given the hundreds of trillions in notional tied to LIBOR it can easily lead to substantial loss estimates. We did some quick back of the envelope calculations for potential industry exposure using the $311 trillion in USD Outstanding OTC interest Rate Swaps as of December 2011 ($403 trillion total less $92 trillion in primary dealers).
But depending on the assumptions (time period involved, level of under-reporting in bps, percentage of outstanding notional that was negatively impacted on a net basis, and the success rate of pursued claims), one can yield potential exposure from a few billion to hundreds of billions, so we’re not sure how useful that sensitivity analysis is…
We think that given the complexity involved with this type of case, that the parties (including the regulators) may be persuaded at some point to pursue the settlement route.
Probably right. Sorry.
But what interested us more from the Nomura note was the useful overview it provided of the defences that the banks have used thus far in lawsuits that were consolidated into one case earlier this month. The reasoning might be a preview of many more suits to come, and we suspect some of it might even be used in the expected criminal cases.
The analysts first begin by emphasising why the complexity of the Libor cases will make it difficult for the plaintiffs to prove their case:
The following are a few questions that illustrate the complexity of the LIBOR cases:
1) To what extent did a single daily misrepresentation actually impact the LIBOR setting process?,
2) Over what time period and inter-periods were losses actually incurred?,
3) What are the offsetting benefits received by any specific plaintiff (pay floating leg, etc)?,
4) How do you assess damages given Libor is a bank’s perceived funding cost, not an actual rate based on an actual transaction?,
5) Does encouragement from Central Banks to keep Libor low help as a defense?,
6) If banks are found liable for some underpayment, will those that gained have to disgorge profits or pay higher interest rates for loans that were underpriced?…
More specific to the LIBOR setting process, we believe it would be hard to prove that any particular bank had a significant impact on the composite LIBOR rate especially if it was part of the outlier group that was not included in the trimmed mean. You would have to prove that a large group of banks together manipulated the rate (specifically on the reset dates) which we believe is a harder case to prove.
Moreover, LIBOR rates “is not a ‘price’ of anything” but rather a composite index derived from the BBA’s survey of panel banks. “There are no buyers or sellers, no market profit, and no competition of any kind associated with the mere reporting of rates or setting of USD LIBOR.” LIBOR is based on banks’ perception of their cost of unsecured funds in the London interbank market. The fact that LIBOR is not based on transactions but a composite index of survey responses will likely make it harder for plaintiffs to prove their case.
The quotes in the last paragraph above are taken directly from the motion to dismiss filed jointly by the banks.
We read through it as well and think the Nomura analysts have done a decent job of summarising the various defences. Extended excerpt:
The banks’ defendant argument for dismissal is four pronged. The banks argue that:
1) Even if the plaintiffs’ claims that banks reported artificially low USD LIBOR rates, the plaintiffs allegations “fails to meet the Twombly standard for plausibly alleging an antitrust conspiracy” – meaning, does that really prove that they colluded or acted jointly?
2) Even if the plaintiffs’ allegations pass the Twombly standard, the plaintiffs’ claims are aimed at alleged false reporting of USD LIBOR rates and do not allege any conduct that would constitute a “restraint of trade” in violation of the Sherman Act (a critical point to any antitrust cases) – meaning, as a reference rate, did any of this actually restrict trade?
3) The Plaintiffs lack the antitrust standing to bring their claims because their alleged injuries are, at best, highly speculative and indirect (simply put, the banks argue it would be difficult, if not impossible, to prove and quantify injury based on rates that are hypothetical and not transaction based).
4) Those plaintiffs that did not transact in USD LIBOR-based products directly withthe banks are not allowed to bring such claims (barred by the Illinois Brick doctrine) – meaning, you could potentially only sue a bank that you bought the products from (and not everyone).
On the first prong, the banks argue that whether or not the plaintiffs’ claim that the banks falsely reported USD LIBOR is true does not support the Twombly test (U.S. SupremeCourt ruling in Bell Atlantic v. Twombly) that the banks acted together to manipulate the LIBOR rate. Barring smoking gun evidence (such as emails or recordings), we believe the plaintiffs face a difficult task of proving this point.
We would argue that during the financial crisis banks had the common incentive to report artificially low LIBOR rates toavoid signaling weakness to the markets and ensure their own survival (not to mention that the Fed was officially targeting low rates and implementing various unconventionalmonetary policy to save the banks).
In addition, each bank has the same incentive to report low LIBOR rates because, in general, doing so would potentially lower their funding costs. Thus, each bank could have acted on its own to report artificial low rates at the same time though in aggregate it would appear they were acting jointly.
The second prong of the banks’ argument hinges on whether or not the alleged conduct would have restrained trade in violation of the Sherman Antitrust Act. The banks argue that trade was not restrained because LIBOR rates are not transaction based. LIBOR rates “is not a ‘price’ of anything” but rather a composite index derived from the BBA’s survey of panel banks. “There are no buyers or sellers, no market profit, and nocompetition of any kind associated with the mere reporting of rates or setting of USDLIBOR.” Furthermore, the banks argue that “market participants are free to make use of or disregard USD LIBOR as they see fit when negotiating rates for new transactions.”
The third prong of the banks’ argument rests on the fact that the plaintiffs lack standing to bring antitrust claims because their alleged injuries either cannot be quantified or are indirect. This is due to the fact that “there is no objectively verifiable ‘correct’ USD LIBOR” because LIBOR does not reflect actual transactions but rather are rates of where each bank thinks it could fund at. Moreover, many purchasers of LIBOR–based instruments could have actually benefitted from the artificially low rates (one OTC plaintiff admitted it may have been indifferent to USD LIBOR movements depending on the instruments purchased).
The fourth prong of the banks’ argument, if valid, would limit any antitrust claims to only those banks that bought LIBOR-based instruments directly from the banks involved inthe lawsuit.
All of it seems rather sanctimonious and cheeky in a way that is probably inevitable for such a kitchen sink legal defence — strong elements of even if we did do it, we didn’t wrong you in the specific way you accused us of wronging you.
More broadly, if the above defences work, that obviously doesn’t rule out the possibility that either these plaintiffs will change their complaints to include accusations of, say, fraud, or that new plaintiffs (expect more) won’t use different approaches.
We’re not legal experts, but looking through the list above it seems as if the third defence — that “there is no objectively verifiable ‘correct’ USD LIBOR” — is the one most likely to apply to future cases where the accusations are indeed different. Not surprising, we suppose. The other defences of course will likely be used again to dispute accusations of collusion among the banks.
At the same time, it’s worth returning to the point made by the Streetwise Prof when the Barclays settlement first appeared. When you’re going from attempted manipulation — which is all the CFTC and other regulators found at Barclays — to actual manipulation, one thing you have to look for is actual interbank trades which gave individual banks’ “real” rates. But the problem with Libor in the first place was that unsecured interbank lending is dying. Has died, in fact. A transaction record will be hard for plaintiffs to locate, surely.
This is all different from the arguments that will play out in public, where you might hear (once the initial outrage has died down) the more standard defences that central banks themselves encouraged low submissions and that many entities, including possibly some of the plaintiffs themselves, benefitted from the lower rates in other transactions. For the record, we don’t buy either of those. (There’s a fetid air of tu quoque over the whole thing.)
There is so much we still don’t know, but Nomura has a point about how the complexity of the fixing process will make it difficult to prove wrongdoing in court outside of explicit smoking gun evidence. Though if the Barclays case has been instructive of what’s coming for other banks, quite a bit of it may very well exist and will surface eventually.
We’ll repeat that we’re not legal experts and don’t really have an informed opinion on the soundness of these defences; we just thought this a handy update of how the banks have responded thus far.