LIBOR RIGGGGGED!!!!!!!!

James Griffith, an officer working in  Financial crimes cell of London Police, was having business as usual over a cup of coffee in his office till he got a call from his senior which moved the earth beneath his feet and his eyes were about to pop out as he muttered in his bewilderment  ’Oh my!!!! Go..........d!” It was bigger than anything he had handled earlier and his imagination failed to gauge the impact of reason of this amazement. To quote very conservatively it is a 15 digit number; 350,000,000,000,000, precisely 350 trillion USD and this humongous amount was riding on a rigged benchmark. Yes, It was none other than LIBOR the most prominent benchmark used globally on which the best of Investment banks and Hedge funds quote their Floating rates and premier banks fix their lending rates. This did not happen anytime soon but as early as 2006. This was indeed scandalous than many other recent scandals!

Read the below:

These are some of the mails between traders who betted on LIBOR and submitters who submitted LIBOR to British bankers Association (BBA) daily.

“WE HAVE TO GET KICKED OUT OF THE FIXINGS TOMORROW!! We need a 4.17 fix in 1m (low fix) We need a 4.41 fix in 3m (high fix)” (November 22, 2005, Senior Trader in New York to Trader in London);

“You need to take a close look at the reset ladder. We need 3M to stay low for the next 3 sets and then I think that we will be completely out of our 3M position. Then its on. [Submitter] has to go crazy with raising 3M Libor.” (February 1, 2006, Trader in New York to Trader in London); 

“Your annoying colleague again … Would love to get a high 1m Also if poss a low 3m … if poss … thanks” (February 3, 2006, Trader in London to Submitter); 

“This is the [book's] risk. We need low 1M and 3M libor. PIs ask [submitter] to get 1M set to 82. That would help a lot” (March 27, 2006, Trader in New York to Trader in London);… 

“Hi Guys, We got a big position in 3m libor for the next 3 days. Can we please keep the lib or fixing at 5.39 for the next few days. It would really help. We do not want it to fix any higher than that. Tks a lot.” (September 13, 2006, Senior Trader in New York to Submitter)…” 

The fundamental principle underlying floating rates is to allow the market to determine borrowing costs. Customers who borrow on a floating-rate basis, if they are sensible, and institutions that loan money on a floating-rate basis, if they are ethical, therefore expect two things from a benchmark interest rate. First, the benchmark should reflect actual conditions in the financial markets. That means no random fluctuations -- money costs what it is worth. Second, the benchmark rate should not be easy to manipulate. No rational, informed borrower would borrow money at a variable rate of interest and then empower the lender to determine when and how the interest rate changed in the future.

So it is startling that Libor, the financial world's most important number, satisfies neither of these requirements. Libor is computed by the British Bankers' Association (BBA), a powerful trade association based in London that represents more than 250 financial institutions. These banks are located in 50 countries and have operations in just about every corner of the globe. But instead of using actual market rates, big banks estimate the interest rate that they think they would have to pay if they borrowed money from other institutions. That is different than reporting the actual interest rate at which they are really borrowing from other banks.

Each day, the BBA sets Libor rates for 15 loan maturities in ten different currencies. In the case of the dollar, 18 banks submit their hypothetical borrowing costs. The BBA discards the four highest and the four lowest submissions considered as outliers distorting the calculation, and then averages the remaining ten to come up with the Libor number. Thompson Reuters calculates all of these rates for the BBA, and then publishes the results, usually around 11:45 AM (CET).  

Rate setting desk were acceding to the traders request and sending the artificial low or high rates to BBA. A low rate quoted to BBA is aimed at keeping the rate so low that it’s taken as outlier and excluded from average rates. This resulted in a lower number forming part of average which would otherwise would have been excluded. Therefore the overall rate was lower than what it could have been with fair play. Though the average was impacted by few basis points, yet the mammoth magnitude of money riding on LIBOR made the outcome substantial.

There are plenty of reasons why banks would like to manipulate Libor rates. During the height of the financial crisis, regulators foolishly looked to Libor to determine the market's perception of the health of big banks. A big bank reporting a low Libor rate was thought to be able to borrow money from other banks cheaply and, therefore, was seen as a safe place to invest. Banks worried about attracting the attention of regulators may have submitted low Libor rates in order to try to deflect regulatory scrutiny. 

More nefariously, banks also manipulated Libor to make money or avoid losses on their trading portfolios. For example, when U.S. traders at Barclays wanted Libor to rise in order to draw a bigger profit on some of their financial products, they simply asked their colleagues at the rate-setting desk in London to push the numbers up or down to suit their needs. Barclays would then submit artificial bids and persuade their counterparts at other banks to do the same.

EURO ZONE CRISIS : NutShell

The euro zone is an economic and monetary union of 17 European Union member states that have adopted the euro (€) as their common currency. The euro zone currently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
Monetary policy of the zone is the responsibility of the European Central Bank (ECB) which is governed by a president and a board of the heads of national central banks. The principal task of the ECB is to keep inflation under control.
Over the past few months, the European debt crisis has become more prominent and has been dominating headlines as the region’s sovereign debt issues continue to cause concern for the EU and potentially other global economies. The debt crisis basically came about because several Euro zone countries have lost control of their finances since the global recession, borrowing and spending more than they could realistically afford. The crisis was triggered by the worldwide financial collapse that began in 2008 and has been exacerbated by poor financial management.
The problem originated in Greece when it was realised that Greece’s deficit was twice as high as originally thought (12.7 per cent of GDP). It has since spread to other countries such as Spain, Ireland, and Portugal. Investors have since become less confident about Greece's ability to repay them and they demanded Greece pay higher interest rates on their bonds. This had a spiral effect as the more Greece had to pay bondholders in interest, the more it had to borrow, which in turn drove up interest rates even more. Greece's debt problems led investors who owned bonds issued by other peripheral Euro zone countries to lose confidence, especially because banks in France, Germany and the UK owned over $56bn worth of Greek government bonds. As a result of the crisis, other European countries have had to bail Greece out. This has cost billions of Euros. Greece was the first country to accept a bailout in May 2010, followed by Ireland and Portugal. However, before these bailouts were approved, the Governments of these countries had to agree to adopt 'austerity measures' to show they were doing what they can to tackle their economic problems themselves. This has led to mass public protests in Greece, with many people demonstrating against more job losses and tax rises as a result. A major concern is that if Greece is unable to keep repaying what it owes to other countries, the country could effectively go bankrupt which would have flow on affects on other countries. The uncertainty surrounding the Euro debt crisis has caused havoc in major world financial markets. This can be reflected in the CBOE volatility index. The Chicago Board of Options Exchange (CBOE) gives a standardised estimate of the market's expectation of future volatility. The index spiked upwards in August to the highest level since the global financial crisis. Over the past few weeks it has become more subdued as EU leaders begin to work out a possible solution to the EU debt crisis. In recent weeks, it appears that the Euro zone has inched closer to a resolution of its crisis. A debt-wracked Italy has come under pressure to introduce new reforms to tackle their own levels of debt. If Italy, the EU zone’s third largest economy, were to default, the bailout fund would become rapidly depleted and ineffective. Options are being explored on ways to scale up the EU’s 440 billion Euro war chest in the case that a larger economy such as Italy or Spain are dragged into the debt mire. One way of doing this is providing insurance to investors so that their losses would be recovered in the event of a debt default. Another option would be to create a separate fund and entice international investors and institutions to match EU commitments, thereby increasing the amount of cash available for potential future bailouts. By using such financial inventiveness, leaders hope to leverage the fund up to as much as a trillion Euros, which they hope will be enough to reassure volatile financial markets. In order to address the crisis, Greece's debt burden needs to be reduced so that the country can eventually stand on its own, banks need to raise more money so they can ride out the financial storm, and show that their European bailout fund is big and nimble enough to prevent larger economies from being dragged into the crisis. This criteria was met in the debt crisis plan which was unveiled in late October. A “Comprehensive” Debt Crisis Plan On the 27th October, 2011, the Euro zone leaders announced a “comprehensive and solid” response to the European debt crisis. The agreement has plans to: Begin negotiations on a nominal 50 per cent cut in bond investments to reduce Greece's debt burden by €100 billion. This would have the affect of cutting Greece’s debts from 160 per cent of GDP to 120 per cent of GDP by 2020. As well as the deal on deeper private sector participation in Greece, Euro zone leaders also agreed to scale up the European Financial Stability Facility (EFSF). The EFSF is Europe’s €440 billion bailout fund which was set up last year. The fund has already been used to provide help to other heavily in debt countries such as Portugal, Ireland and Greece, leaving around €290 billion available. An estimated €250 billion of that will be leveraged four to five times, producing a headline figure of around €1trillion, which will be deployed in a variety of ways. The EFSF will be boosted via both risk insurance and a special vehicle that will buy bonds. Further resources would come from co-operation with the IMF and sovereign wealth funds, including China. The fund would be tasked with ensuring financial stability in the Euro zone. These announcements have provided a degree of relief for international economies and share markets as it appears a tourniquet has been wrapped around the crisis for the time being. A recent announcement by the Prime Minister for Greece (George Papandreou) could undo a lot of the positive outcomes that came out of the debt crisis plan. The Prime Minister has called a referendum on accepting a second bailout plan. This move has renewed fears that Greece could default on its debt and that the Euro zone government debt crisis could deepen. This has shown that the debt crisis plan is only a movement in the right direction in trying to solve the crisis and that it is far from being laid to rest.

Differential Interest Rate Fix (DIRF)

DIFFERENTIAL INTEREST RATE FIX

DESCRIPTION

A Differential Interest Rate Fix (DIRF) is a contract that moves with reference to the SLOPE of a yield curve. The DIRF is meant for those who wish to profit from a steepening or flattening of one yield curve. The DIRF is customised with defined settlement dates, a defined value per basis point, and two defined points on the yield curve.

EXAMPLE

Assume an investor believes that the Italian yield curve will flatten over the next year more than that implied in the market. The client would enter into a flattening DIRF, say 2 years versus 7 years, for settlement in one year. The investor selects the amount per basis point they wish to transact, say ITL 1,000,000 per point. The DIRF price is given in terms of basis points. If at maturity the difference between the 2yr and 7yr ITL Swap rates has flattened below the DIRF level, the investor will receive ITL 1,000,000 for every basis point lower. If the difference is higher than the DIRF level, i.e. the curve has steepened, the investor will lose ITL 1,000,000 per basis point.

PRICING

The entry price is calculated by taking the difference between the implied forward rates for the two yield curve points chosen. This means in the above example, we calculate the one year forward 2yr rate and the one year forward 7 yr rate. The DIRF price is the difference. Investors who BUY the DIRF look to see the curve steepen, investors who SELL the DIRF look to see the curve flatten.

TARGET MARKET

This is a product for people who wish to take a position on the SLOPE of the yield curve without taking an outright position on a curve.

ADVANTAGES

·         Available in all major currencies

·         Can utilise any two points on the yield curve

·         Can be reversed at any time with reference to the then prevailing implied rates

·         Investor determines amount per point sensitivity

·         Settlement at maturity is against independent mid rate quoted on Telerate

·         No Exposure to parallel movement in yield curve

DISADVANTAGES

·         The attractiveness of DIRFs is dependent on the Implied Forward, rates not the spot rates, therefore expected movements can already be built in.

PRODUCT SUITABILITY

Simple Aggressiv