Rigged: part 1 - Will there be a part 2?

I have been reading book “Rigged: The Incredible True Story of the Whistleblowers Jailed after Exposing the Rotten Heart of the Financial” (Andy Verity, Flint, June 2023) for some time. It was published several month ago, but I just finished it. To my defence, I have to say that I don’t feel comfortable reading fiction where the “bad guys” are systematically winning by cheating.

The book is the story of the miscarriage of justice done in the LIBOR manipulation story. The book content did not surprise me. For anybody having worked on a (swap) trading desk, it is clear that what was described by the accusation was impossible. It is not possible for some middle level trader to create a multi-year, multi-desk, multi-bank international conspiracy over open lines, broker lines, on open offices etc. without all around them, including compliance and senior management to be fully aware of what is going on. Moreover the regulators cannot be ignorant of the situation, except pleading complete incompetence, including illiteracy.

I have presented different workshops related to LIBOR transition since 2017. Since 2019, those presentations indicate two types of manipulations: the daily trading and the lowballing. Regarding the second one the presentation indicates “Investigation into the rigging of Libor, the benchmark interest rate that tracks the cost of borrowing cash, has been unexpectedly closed in October 2019.” with reference to a BBC article indicating clearly (in 2019 already) "The decision comes despite evidence that implicates the Bank of England.”

The future will tell us if a similar miscarriage of justice was done related to the death sentence of LIBOR itself. Andrew Baily, the author of ``The future of LIBOR’’ infamous speech was himself highly conflicted in this process. The pre-2008 LIBOR was not perfect; you could improve it or kill it. Improving it meant an in-depth analysis of its features, history and fixing habits. That in-depth analysis would have revealed the inappropriate role played by regulators, central banks and governments in the LIBOR low-balling. That meant revealing the role played by A. Baily in that story. Killing LIBOR was the best way to try to keep his records ``clean’’. Maybe in a couple of years a journalist inquiry will reveal the nefarious game played by the same regulators, central banks and governments in the LIBOR transition.

IOSCO, a regulator organisation is in the same way conflicted by transition. Its members are represented at its board by the personally conflicted persons. When IOSCO is publishing an anonymous hit piece on LIBOR replacements as described in “A personal statement on the IOSCO Statement on Alternatives to USD Libor”, is it for the general public good or to cover the nefarious actions of its representatives.

The official question to which the LIBOR setters had to answer was ``At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am?’’

To make my comment cleared, I will rephrase the question with a slightly different grammar. ``What is the/a rate a which you could borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am?’’

The first sentence hides behind the grammar the fact that it is not clear if the article in front of the “rate” is an indefinite article (a) or a definite article (the). This makes all the difference in the world about the LIBOR ``scandal'’. Is there a unique well defined rate behind LIBOR or a range of acceptable rates? In all the (mis-)trials of LIBOR setters and traders, the prosecutors hide their accusations behind that ambiguity, securing ``guilty pleas'’ by blackmailing some middle-level bankers without any clear reference to actual laws and rules that were broken.

Then we continue the sentence with ``could’’ and ``were’’. There was no requirement of an actual transaction, only the opinion of the rate setter about what someone else would answer to a question that was not even asked. The issue with LIBOR was not the ``arrangements’’ for a tenth of a basis point of two by some bankers, it was the agreement by the banking industry in general and the regulators in particular that such an ambiguous figure would be the ``most important number in the world’’. Even if the LIBOR setting process was not officially regulated, the LIBOR name was often mentioned by central banks in relation to their monetary policies as a good indication of market rates. It implicitly gave credit to the process. And we come back to the indefinite article question. If the rate is hypothetical, as indicated by the ``could’’, how is it possible that the rate published has 7 decimals (5 when expressed in %)? The guess of 15 or so people leads to a rate with 7 decimals? This is a false sense of precision. Note that the original LIBOR in 1986 was up to a precision of 1/16 of a percent (6.25 basis points). That looked more reasonable in terms of precision.

The sentence ends with ``just prior to 11:00 am”. Even if slightly imprecise with the ``prior’’ term there is at least a timing indication. The replacement rates that have been forced to the market by central banks and regulators, like SONIA, SOFR, ESTR or Term SOFR, do not even have that quality. SOFR for example is a ``daily volume weighted median’’. How do you hedge a ``daily volume weighted’’ number? How do you hedge a median number? The number is not representative of a market, it is representative of an accumulation of different markets. Moreover the market is manipulated by the same central bank, with hundreds of billions offered daily by the central bank in that same repo market. Also the regulation, like EU Benchmark Regulation (BMR), exempts the central bank of the registration and overview process to be allowed to publish a benchmark used in financial markets.

Was the previous LIBOR benchmark centric market perfect? Certainly not! Is the new central bank manipulated overnight benchmark centric market better? That needs to be seen in the long term!

That was part 1 of the “Rigged”. What would be part 2? The part 1 had a consequence of a very expensive and unfair transition to anticipatively remove LIBOR. I have described why I used “unfair” in numerous posts in this blog and on my professional blog. The part 2 would have a similar rigged process for the transition. The central banks and regulators have played an important role in the transition. From the (in-)famous “the future of LIBOR” speech through the ARRC and similar committees to the synthetic LIBOR. Non-transparent decisions have been taken, creating billions of value transfers between market participants, from the smallest retail customers to the largest market makers. As one example of this unfair and non-transparent decision, we can look at the LIBOR conversion. ISDA ran a consultation process, itself not transparent and biassed, for a new definition to be applied to new trade. In a weak sense that was fair as the new definition is published before the participants trade on that new definition. But then regulators threaten participants with “difficult questions” if they don’t sign the protocol; the protocol which applies a new definition to old trades is by construction unfair. The CCP decided to apply the new definition also to the old trades, again unfair. But because the new definition are unmanageable from a risk perspective, as I have cautioned for a long time (see for example Signing the LIBOR fallback protocol: a cautionary tale), the CCP did not actually used the new definition but a variation of it that I advised for several years (see CME steers away from ISDA fallback). And finally (really finally?) because all those threats and manipulations were not enough, the regulators invented the synthetic LIBOR to force those unfair changes to those who have resisted. This was done through a dictatorial power given to the regulators by the UK BMR as described in Synthetic LIBOR, genuine manipulation.

That was a long rant, but it sounds to me that there are enough question marks in this process that could lead to a “Rigged: part 2 - the manipulation of the transition” after “Rigged: part 1 - the manipulation of the manipulation”.

But as a warning, I have been very bad at forecasting over the last years, always expecting that common sense would prevail. Clearly I’m not adapted to the real world. I should go back to theory!