Libor Scandal and Shipping
July 12, 2012 Leave a comment
Is your every keystroke, phone call, email, BBM and Yahoo! message recorded? Is there CCTV above your desk recording what you are reading and who comes to talk to you? Do you have to pass mandatory online compliance tests or risk being locked out of your computer? Are you subject to random drug and alcohol testing? Can you be fined and jailed for failing to report suspicious behaviour or transactions? Then you are working for a bank.
Which is why there is so much evidence against the traders manipulating Libor, and why Barclays choose to settle early (see Why Lie about Libor and Eurobor?).
So how does affect shipping? First, there were two manipulations of Libor going on (see this NY Times link for explanation of Libor). The first was a cartel of banks quoting higher or lower rates to make a profit on the derivatives side or their business. This was easy money as Libor is only an opinion on the interest rate a bank might have to pay other banks to borrow funds on that day. Derivatives traders were breaching the Chinese Walls within banks to tell the analysts the rate they required to be quoted. The beauty of this deal is that Libor was a benchmark invented to give an indicative rate when there is no liquidity. So as long as the rate fixing bank wasn’t in the market to borrow funds then who is to know? And even if it did enter the market, only the counter party would be aware of the actual interest rate paid, and it was in no one’s interest to report actual rates. In order for the manipulation to work a large number of the 18 banks setting Libor had to be involved. Finally, there was no back testing of Libor so statistical oddities were not being investigated.
The second manipulation was to fake the level a bank had to borrow funds from other banks to as to disguise the level of distrust in its ability to repay. The defense here is that it was for the common good, or there would have been a run on weaker banks. In the case of Barclays there is some suspicion that there may have been hints from on high that not quoting the actual rate at the time might be a good thing all round, old boy.
So going back to shipping, what is the impact? First, for borrowers up to 2007 it seems Libor may on the whole have been manipulated upward (some estimate manipulation of Libor has being going on for 15 years), so pre-2007 borrowing costs may have artificially higher. In the crisis from Lehman Brothers onward it seems the manipulation was toward lower interest rates, so borrowers may have been paying less. But during this period owners would have been asked to put funds on deposit to get a high enough internal rating to be considered for a deal, so then they would have lost out on the lower interest rate. Second, and potentially the biggest liability for banks, are derivatives, such as interest rate swaps. Does an owner have to stand by the swap that is out of the money now we know the rate was manipulated? Can owners claim for the losses on all derivatives, such as bunker hedging, commodities futures and FFAs? Third, owners are only going to sue if they are out-of-pocket, but banks can hardly sue the owners who profited from the banks illegal activities. After all, even in a low rate environment, moving the rate by a few bps would generate huge income for the bank’s derivative department (see Why Lie… again). As a result, shipping departments in banks, which are only asset lending on low margins, may be hit with more losses from owners pulling out or sueing over derivatives, which they were asked to cross-sell.
Finally, the slack rules around Libor will trigger another wave of finance regulations, and these may be applied to all benchmark rate setting and indices which are used as, and / or derive financial instruments, and this could include shipping exchanges and shipping indices. New rules may include only reporting actual rates or agreed statistically derived alternatives in times of low liquidity. Increasing the number of reporting institutions on a benchmark panel to ensure a rate can be reported. Back testing and investigation of statistical oddities. So; is your every keystroke, phone call, email, BBM and Yahoo! message recorded? Is there CCTV above your desk recording what you are reading and who comes to talk to you? Do you have to pass mandatory online compliance tests or risk being locked out of your computer? Are you subject to random drug and alcohol testing? Can you be fined and jailed for failing to report suspicious behaviour or transactions? Then you are working for a shipbroker.
Copyright; Craig Jallal. All Rights Reserved.