Andrew Hepburn is a former hedge fund researcher. He writes on commodities, the stock market and the financial industry–but without the jargon.
Is there an epidemic of price-fixing and market manipulation? Recent headlines certainly raise the question.
On June 28, Britain’s Barclays Bank agreed to pay over $450 million to settle allegations that it attempted to manipulate the London Inter-Bank Offered Rate (LIBOR), a crucial global interest rate. LIBOR is (supposedly) the rate at which banks can borrow funds from other banks. It is a key measure of stress in financial markets: When banks start getting nervous about lending to each other (therefore charging one another higher interest rates), it’s a sure sign we’re all in trouble. LIBOR is used as a benchmark for interest rates the world over and affects everything from student loans to mortgage payments. And LIBOR is not an ordinary rate: It is calculated based on the daily submissions of up to 18 global banks, depending on the currency in question (rates are published for 10 different currencies).
Barclays attempted to manipulate LIBOR both to give a false impression of the bank’s health and also to benefit its trading positions. It did not do so alone: traders coordinated their activities with other banks to ensure successful manipulations. For example, let’s say Barclays had accumulated bets that interest rates would rise. Submitting artificially high estimates of how much it cost the bank to borrow funds would tend to push the published LIBOR rate higher, thus benefitting its trading positions. To do so, however, it would need to collude with other banks, because the highest and lowest submissions are automatically excluded in the calculation of LIBOR.
The LIBOR scandal by itself is shocking, but there are other recent examples of outrageous (alleged) manipulation. On July 2, a former trader for Glencore International, the world’s largest commodities company, sued rival Louis Dreyfus Commodities for allegedly causing an artificial spike in the price of cotton. The alleged scam cost Glencore over $300 million and the trader in question was fired.
There’s more. On July 3, the Federal Energy Regulatory Commission announced it had started investigating JP Morgan Chase for possible manipulation of the California and Midwest power markets. This is in addition to previously announced probes of Deutsche Bank and Barclays for similar violations. (And, as you may remember, Enron infamously manipulated the California electricity market years ago.)
So, are we seeing an epidemic of manipulation in the financial industry? Is this just the latest display of crass disregard for the law by the Gordon Gekkos of the world?
Not quite. Even outside the world of finance, manipulation is constantly making news. Only last week Toshiba was fined $87 million after being found guilty of colluding to fix prices in the market for LCDs (liquid crystal displays), used in products such as televisions and computers. A couple of days later, railroad manufacturers in Germany were fined over $170 million for fixing the price of rails sold to Deutsche Bahn, the nation’s railway operator.
The truth is, though, that price-fixers are less likely to be caught or punished severely in the financial industry.
Admittedly, authorities across the developed world have become quite adept at spotting and cracking down on manipulation and cartel behaviour in a number of other areas. In the U.S., for example, anti-trust laws provide significant civil and criminal penalties for those found guilty of cartel behaviour—and there have been some notable enforcement actions. The same goes for the European Union. As recently as 2010, the European Commission fined 11 airlines almost $1 billion for fixing the price of air cargo.
Yet with the exception of stocks, regulators have made comparatively little headway in combating market manipulation in the world of finance. The U.S. Commodities Futures Trading Commission, for example, has only successfully prosecuted one case of market manipulation in its entire history (though there have been some cases of–mostly modest–settlements along the way). This, in turn, has contributed to various shenanigans mushrooming across the industry.
There are a few reasons for this. First, until very recently, the legal bar necessary to prove manipulation was incredibly high. Regulators had to show that a defendant intended to manipulate a market, and also that the outcome of her actions was to create an “artificial” price. To prove the former, authorities essentially needed smoking guns like the emails linked to the recent Barclays scandal. And even if they’re lucky enough to obtain some such blatant proof of criminal intent, establishing that a given price moved as a result of manipulation rather than a myriad other market forces isn’t easy.
It has not helped matters that in the U.K., home to one of the world’s biggest financial centres, regulators long allowed market manipulation to take place as an accepted practice. In a famous speech in 2005 then-chancellor of the exchequer Gordon Brown explicitly praised U.K. regulation for having “not just a light touch but a limited touch,” including when it came to scrutinizing the financial services industry. Brown spoke of trusting companies to do the right thing, trust that is starting to look disastrously misplaced in light of the LIBOR scandal. Not surprisingly, other markets–such as oil–largely based on self-reported figures are starting to attract scrutiny.
In the U.S., one just needs to think of how long Bernie Madoff was able to escape the law, to suspect that the close connection between Wall Street and Washington helped prevent an earlier crackdown on market manipulation.
Luckily, though, things are starting to change. The recent Dodd-Frank financial regulation law has made it easier for U.S. regulators to prove manipulation. (The problem is that the CFTC is woefully understaffed–not to mention that Republicans just voted to cut the budget of the agency by 12 per cent). In the U.K. too regulators are starting to view market manipulation differently. In 2010 the Financial Services Authority fined a coffee broker almost $150,000 for price-fixing activities and banned him from working in the financial industry. Reuters noted at the time that this constituted “the first successful action for market abuse in commodity markets”. The broker had been working to influence coffee prices towards the end of a trading day, something regulators used to tacitly overlook as an “accepted market practice.”
The jury is still out on whether the recent efforts to crack down on financiers who fiddle with the numbers have enough bite to significantly deter the practice and change the culture of the industry. How the LIBOR scandal will be handled will be a important indicator of whether regulators are truly catching up.