Inside Practice: LIBOR Benchmark Manipulation and the Quantification of Harm in Damages Actions

Amy DunneKnowledge Management, Freshfields Bruckhaus Deringer* (Brussels)

In the press release accompanying the settlement decisions in the EIRD and YIRD investigations of 4th December 2013,[1] the Commission reaffirmed its resolve to “fight and sanction these cartels in the financial sector.”[2] The purge of cartel behaviour in the financial sector has been shown to yield evidence of genuine collusion amongst financial institutions. The practices attracting scrutiny primarily relate to information exchange, price signalling and benchmarking. The attendant results of these investigations have seen large deterrent fines levied on recalcitrant market participants.[3] However, with the advent of the Damages Directive on the 26th November 2014,[4] cartelists in the financial sector now also face exposure to private litigation from damages claimants in addition to Commission fines. The impact of these follow on claims has been hypothesized to potentially outweigh the large fines imposed by the Commission – “significant levels of follow on claims may dwarf the original fines.[5] This contribution endeavours to highlight the particular complexities associated with the quantification of harm in damages actions concerning the practice of benchmark manipulation. In order to conceptualise these difficulties, reference is made to the LIBOR (‘London InterBank Offered Rate’) scandal. Specific regard is had to the LIBOR scandal given that follow on claims have already been litigated and/or settled in the UK.

1.1 LIBOR Benchmark Manipulation

In 2011, the Commission initiated an investigation into the manipulation of LIBOR and other financial benchmarks utilised by financial institutions under Article 101 TFEU. In Regulation (EU) No 596/2014 of the European Parliament and of the Council of 16 April 2014 on Market Abuse [Market Abuse Regulation or ‘MAR’],[6] a benchmark is defined as

“any rate, index or figure, made available to the public or published that is periodically or regularly determined by the application of a formula to, or on the basis of the value of one or more underlying assets or prices, including estimated prices, actual or estimated interest rates or other values, or surveys, and by reference to which the amount payable under a financial instrument or the value of a financial instrument is determined.”[7]

The evidence uncovered in the LIBOR investigations indicated that a number of financial institutions and at least one financial broker had participated in anticompetitive conduct relating to the manipulation of LIBOR and the EURIBOR benchmark in the period 2005 -2010.

Following from investigations into the financial sector, various legislative initiatives were undertaken to curb benchmark manipulation. These initiatives serve to highlight the nature and gravity of the impugned behaviour. The Market Abuse Regulation [“MAR”] in Articles 2(3)(d) and 8(1)(d) and the Criminal Sanctions for Market Abuse Directive [“MAD”][8] now clarifies that any manipulation of benchmarks is illegal and subject to administrative or criminal sanctions. In Article 12(1)(d) of the MAR, it is set out that transmitting false or misleading information or providing false or misleading inputs in relation to a benchmark or any other behaviour which manipulates the calculation of a benchmark constitutes market manipulation. Market manipulation is described as an “interference with the free and fair operation of a market, conducted with the intent to create a misleading price or a misleading trading activity.”[9]

1.2 Preparation of LIBOR

LIBOR is used to determine payments made under interest-rate contracts; by a wide range of counterparties, including small businesses, large financial institutions and public authorities. LIBOR is calculated for five different currencies[10] and seven different maturities[11] (overnight -12 months). It is derived from:

the average of submissions provided by 16 major banks, with the upper and lower quartile of submissions excluded for calculation purposes. The submissions relate to estimated short term inter-bank borrowing rates (rather than actual transaction data).”[12]

As official economists to an investigated undertaking in the Commission’s investigation of LIBOR manipulation, OXERA noted that due to the sampling preparation process of LIBOR, market players were more susceptible to the formation of genuine cartels and, consequently, per se infringements[13] rather than mere benchmark manipulation:

“given the sampling process, unilateral attempts at manipulating LIBOR could be less successful than coordinated attempts involving more than one bank.”[14]

1.3 LIBOR Follow-on Claims

Given that LIBOR is used as a reference rate for hundreds of trillions of dollars, follow-on damages claims have the potential to be significant in number.[15] The potential magnitude of claims is compounded by the possibility of claimants initiating an ‘umbrella claim’[16] under the Damages Directive; under this mechanism, claims may arise against cartelists where LIBOR was used as a benchmark in a financial transaction between two third parties.

However, claims thus far arising in the UK have proceeded on the grounds of alleged misrepresentation, by way of reference to LIBOR manipulated benchmark, with the objective to release the party from unfavourable derivative contracts. [17] The UK therefore awaits its first true ‘test-case’ damages claim to be brought alleging loss suffered as a direct or indirect result of LIBOR manipulation.

Establishing the effects of benchmark manipulation on the market is contextualised below as one of the factors, inter alia quantification of harm, to be established in presenting a comprehensive damages claim.

3.1 Establishing a Damages Claim: Benchmark Manipulation

The three formal hurdles to establish a damages claim are (i) liability, (ii) causation and (iii) quantification of harm. The EU Commission infringement decisions in LIBOR establish liability for damages actions under domestic competition law. Commission infringement decisions are binding on UK courts, thereby establishing liability but leaving damages to be proven. A causal relationship must thereafter be established between the harm suffered and the infringement of competition law.

3.2 Quantification of Harm in Benchmark Manipulation cases

An injured party, who has proven a causal relationship between the harm suffered and the competition law infringement, still needs to prove the extent of the harm in order to obtain damages.[18] Apart from the establishment of liability and causation, it is the determination of the quantification of harm which is likely to take centre-stage in benchmark manipulation damages actions.

Quantifying harm in competition law cases is a fact-intensive process. Harm in the form of actual loss can result from the price difference between what was actually paid and what would otherwise have been paid in the absence of the infringement.[19] Calculating the damage arising from an assessment of what would have happened in a hypothetical scenario where the infringement has not taken place is known as the counterfactual.

As above, given the proliferation of genuine cartels in the financial market, as opposed to the mere manipulation of benchmarks alone, investigations thus far have been focused on the object per se infringements of the cartelist, without determining the actual effect of the cartelist’s behaviour.[20] Whilst it is presumed that cartel infringements cause harm under the Damages Directive,[21] without a determination of the actual effect of the cartelist’s behaviour in the infringement decision, a greater burden is placed on the private litigant to set out a credible quantification of harm.

3.3 The Difficulties of Effects-Based Analysis of Benchmark Manipulation

The impugned behaviour underlying the LIBOR cartel is now well-espoused at European level as anti-competitive.[22] However, less ascertainable are the actual anti-competitive effects on the market which benchmark manipulation elicits in specific cases.

Firstly, with reference to the methodology of preparing the LIBOR-rate as set out above, it can be appreciated that establishing a counterfactual LIBOR price is especially complex given that:

“the calculation of LIBOR is not based on actual market transactions between banks, but rather a bank’s estimate of what its borrowing cost would be at a certain size. The counterfactual of banks’ LIBOR submissions and resulting LIBOR rates would require careful analysis.”[23]

Therefore, an assessment would require convincing evidence, economic and otherwise, to establish a credible counterfactual. An abundance of data on financial transactions which would assists the conception of a credible counterfactual scenario no doubt exists. However, assuming the disclosure of all relevant materials, a private litigant would have to process large volumes of financial records relevant to the period of the impugned behaviour to evince a sophisticated economic analysis of the ‘but-for’ LIBOR price. This undertaking would require significant expertise and funding.

OXERA, the economics consultancy, also points to further evidentiary burdens given that the period covered by the LIBOR cartel spans the height of the financial crisis, in which banks lent to each other less frequently, leading to a lower number of actual transactions to observe for comparison purposes.

Secondly, it must be appreciated that there is no objective definition of market manipulation.[24] In particular, not all instances of market manipulation are necessarily harmful to all parties concerned. For example, in the case of the LIBOR scandal, borrowers would benefit from lower LIBOR rates while savers would suffer. It is expected that LIBOR was influenced upwards and downwards at various intervals. As per OXERA, “it is unlikely that traders at financial institutions that manipulated LIBOR would have tried to push LIBOR in only one direction; rather, they would be likely to have desired a higher or lower rate depending on their net long or short position on any given day.”[25] This point is only tentatively accounted for in EU legislation, as per: if a benchmark is manipulated this will cause significant losses to some of the investors that own financial instruments whose value is determined by reference to the benchmark.”[26] Therefore, the practice of benchmark manipulation may have benefitted as well as negatively impacted the claimant over a period of time. Any quantification of harm must consequently take adequate account of the potential benefits reaped by a claimant during the same period. In the context of passing-on, it should be considered whether a direct claimant may have mitigated losses by passing on any LIBOR ‘overcharge’ to their own customers.

The Damages Directive foresees that difficulties may be encountered in the quantification of damages and, therefore, Member States are required to ensure that national courts are empowered in accordance with national procedures to estimate the amount of harm if it is established that a claimant suffered harm but it is practically impossible to excessively difficult precisely to quantify the harm suffered on the basis of the evidence available.[27] It remains to be seen how proactive and adept the courts will prove to be in this evaluation with respect to benchmark manipulation. However, as per Justice Rose, “one advantage of counterfactuals is that, when predicting the past, it is impossible to say whether the court is right or wrong in the conclusions it reaches.”[28]

  1. Concluding Remarks

An opportunity to elicit a comprehensive effects-based analysis of benchmark manipulation has not yet arisen at Commission or national level. It is plausible that the particular complexities and costs associated with the quantification of harm in damages actions relating to the anti-competitive practice of benchmark manipulation may currently render potential claims uneconomic to litigate without third party funding. Further scholarship on the modality of quantifying the harm related to the anti-competitive practice of benchmark manipulation and/or an effects-based damages ‘test-case’ in which the quantification of harm as a result of benchmark manipulation is set out in detail is therefore eagerly awaited.

________________________________________________________________________

**Any errors or opinions expressed remain the responsibility of the author.

[1] Commission Decision, IP/13/1208, ‘Antitrust: Commission fines banks €1.71 billion for participating in cartels in the interest rate derivatives industry’, 4th December 2013; available at ‹http://europa.eu/rapid/press-release_IP-13-1208_en.htm›

[2] Joaquin Almunia, ‘Introductory Remarks on Cartels in the Financial Sector’, Speech-13-1020, 4th December 2013; available at ‹http://europa.eu/rapid/press-release_SPEECH-13-1020_en.htm›

[3] In YIRD, the Commission has settled with five banks and one cash broker for €669.7 million.  The investigation is still ongoing for broker ICAP as alleged facilitator in benchmark manipulation. In EIRD, the Commission has settled with four banks for €1.04 billion, with the investigation is still ongoing for three banks who have abstained from the settlement procedure. This year, in October alone, the Commission reached a settlement for €61.6 million in the Swiss Libor investigation and a settlement with four banks for €32.3 million in the Swiss bid-ask spreads investigation.

[4] Directive 2014/104/EU on certain rules governing actions for damages under national law for infringements of the competition law provisions of the Member States and of the European Union, OJ L 349/1 5.12.2014 [Damages Directive]

[5] John Schmidt, ‘Cartels and Follow on Actions in the Financial Services Sector’, IBC Conference on Competition Challenges in the Financial Sector 2014, Shepherd & Wedderburn, 12th June 2014; available at ‹ http://www.shepwedd.co.uk/sites/default/files/Cartels%20and%20Follow%20ups.pdf ›

[6] L 173/1 OJ 12.06.2014.

[7] Ibid., recital (29).

[8] Directive 2014/57/EU of the European Parliament and of the Council of 16 April 2014 on criminal sanctions for market abuse (market abuse directive) OJ 12.06.2014 L 173/179.

[9] Talis J Putnins, ‘Market manipulation: A survey’, Journal of Economic Surveys, Vol. 26, No. 5, pp. 952-967.

[10] CHF (Swiss Franc), EUR (Euro), GBP (Pound Sterling), JPY (Japanese Yen), USD (US Dollar). The AUD (Australian dollar), CAD (Canadian dollar), DKK (Danish krone), NZD (New Zealand dollar) and SEK (Swedish krona) LIBOR rates were discontinued in 2013 as recommended by the publication of the Wheatley Review of LIBOR, published in September 2012.

[11] Overnight, 1 week, 1 month, 2 months, 3 months, 6 months, 12 months. It was also used to evaluate 8 more maturities (2 weeks, 4, 5, 7, 8, 9, 10 and 11 months).

[12] Tom Dane, ‘LIBOR scandal: two years on’, Nabarro, 4th June 2014; available at ‹ http://www.nabarro.com/insight/briefings/2014/june/libor-scandal-two-years-on/›

[13] Joaquin Almunia, Op. Cit.; ‘Indeed, what is shocking about the LIBOR and EURIBOR scandals is not just the manipulation of benchmarks, but also the setting up of genuine cartels between a number of financial players.’

[14] OXERA, ‘Agenda – LIBOR damages claims: Counterparties and Complex Counterfactuals’, February 2014, available at ‹http://www.oxera.com/Latest-Thinking/Agenda/2014/LIBOR-damages-claims-counterparties-and-complex-co.aspx› This report is recommended for an expert overview.

[15] In 2012, the Wall Street Journal also reported that “more than $800 trillion in securities and loans are linked to the Libor, including $350 trillion in swaps and $10 trillion in loans.” Sara Schaefer Munoz and Max Colchester, ‘Barclay’s Agius is Stepping Down’, July 2012. In 2013, the Financial Times reported that USD $506 trillion of financial derivatives were be pegged to the LIBOR rate. Ben Freese and Johanna Kassel, Financial Times, ‘Understanding Libor’, February 2013. An exact figure is unknown.

[16] An umbrella claim is one in which the claimant did not deal directly with the cartelists, but is nevertheless suing for damages because the prices it paid were inflated by the actions of the cartel.

[17] Guardian Healthcare Homes (Graisely) v Barclays concerns misrepresentation in the selling of interest-rate swaps which were pegged to the manipulated LIBOR benchmark rate in 2007 and 2008. The case was settled was in April 2014. The Deutche Bank v Unitech Global Limited is still ongoing. Also in April 2014, Barclays settled Domingos Da Silva Teixeira v Barclays case involving alleged misrepresentation in the selling of 16 unsuitable derivative contracts.

[18] Recital (45), Damages Directive, Op. Cit.

[19] Recital (39), Damages Directive, Op. Cit.

[20] OXERA Report, Op. Cit.; “Drawing a parallel with cartel damages cases, thus far LIBOR has been mostly a matter of investigating an object (per se) infringement of the rules, without determination of the actual effect of the behaviour.”

[21] Article 17(2), Damages Directive, Op. Cit.

[22] Following the EURIBOR and LIBOR scandals, the Commission has further proposed draft legislation:, Proposal for a Regulation of the European Parliament and of the Council on indices used as benchmarks in financial instruments and financial contract, COM/2013/0641, 18th September 2013 which seeks to restore confidence in the integrity of benchmarks  and regulate benchmarks susceptible to manipulation especially where conflicts of interest and/or discretion which are not subject to adequate governance and controls subsist.

[23] OXERA Report, Op. Cit.

[24] Talis J. Putnins, Op. Cit.; at page 4 et seq. “There is no generally accepted definition of market manipulation. This may seem surprising given the long history of manipulation in world financial markets and the fact that more than three quarters of a century has passed since the inception of US federal securities regulation against market manipulation.”

[25] OXERA, Op. Cit.

[26] European Commission, Proposal for a Regulation of the European Parliament and of the Council on indices used as benchmarks in financial instruments and financial contracts, COM(2013) 641; at page 2. Emphasis added.

[27] Article 17(1), Damages Directive, Op. Cit.

[28] Dame Vivien Rose DBE, Justice of the High Court, Chancery Division, ‘Predicting the Past Constructing the Counterfactual in Antitrust Damages Claims’, Conference on the Pros and Cons of Counterfactuals, Stockholm, 6th December 2013 available at ‹http://www.kkv.se/globalassets/english/research/presentation-by-vivien-rose-predicting-the-past-constructing-counterfactuals-in-antitrust-damages-claims.pdf›