The Banking Law Journal Volume 129
Number 9 October 2012
Headnote: The Source-of-Strength Doctrine Steven A. Meyerowitz
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The Source-of-Strength Doctrine: Revered and Revisited — Part I Paul L. Lee
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Banks at Risk: Foreign Corrupt Practices Act Allows Seizures of Customer Bank Accounts Harold P. Reichwald, Jacqueline C. Wolff, and Jeremy R. Lacks
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CFPB Proposes New Mortgage Disclosure Rules Michael B. Mierzewski and Jeremy W. Hochberg
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Mortgage Underwriting: The Qualified Mortgage and Ability to Repay Rules Elizabeth L. McKeen, Trevor Lain, and Dixie Noonan
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Implications for Commercial Organizations of the Global Investigations into LIBOR Christine A. Edwards, Patrick M. Hardiman, Michael Madden, and Justin McClelland
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LIBOR: The Wheatley Review Charles Proctor
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CLS Bank v. Alice Corporation and Bancorp Services v. Sun Life: Contrary Outcomes in Latest Federal Circuit Decisions on Patent-Eligibility of Financial Services Inventions Robert H. Fischer, Douglas Sharrott, and Josh Calabro
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Third FATCA Compliance Model Announced John Clay Taylor, Hap Shashy, and Sara Silverstein
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Banking Briefs Terence G. Banich
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Editor-in-chief Steven A. Meyerowitz President, Meyerowitz Communications Inc. Board of Editors Paul Barron Professor of Law Tulane Univ. School of Law George Brandon Partner, Squire, Sanders & Dempsey LLP Barkley Clark Partner, Stinson Morrison Hecker LLP John F. Dolan Professor of Law Wayne State Univ. Law School Thomas J. Hall Partner, Chadbourne & Parke LLP Kirk D. Jensen Partner, BuckleySandler LLP Satish M. Kini Partner, Debevoise & Plimpton LLP
Paul L. Lee Partner, Debevoise & Plimpton LLP Jonathan R. Macey Professor of Law Yale Law School Martin Mayer The Brookings Institution Stephen J. Newman Partner, Stroock & Stroock & Lavan LLP Sarah L. Reid Partner, Kelley Drye & Warren LLP Heath P. Tarbert Partner, Weil, Gotshal & Manges LLP Stephen B. Weissman Partner, Rivkin Radler LLP
Bankruptcy for Bankers Howard Seife Partner, Chadbourne & Parke LLP Regional Banking Outlook James F. Bauerle Keevican Weiss Bauerle & Hirsch LLC Recapitalizations Christopher J. Zinski Partner, Schiff Hardin LLP Banking Briefs Terence G. Banich Member, Shaw Gussis Fishman Glantz Wolfson & Towbin LLC Intellectual Property Stephen T. Schreiner Partner, Goodwin Procter LLP
Elizabeth C. Yen Partner, Hudson Cook, LLP
Douglas Landy Partner, Allen & Overy LLP
The Banking Law Journal (ISSN 0005 5506) (USPS 003-160) is published ten times a year by A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207. Periodicals Postage Paid at Washington, D.C., and at additional mailing offices. Copyright © 2012 THOMPSON MEDIA GROUP LLC. All rights reserved. No part of this journal may be reproduced in any form — by microfilm, xerography, or otherwise — or incorporated into any information retrieval system without the written permission of the copyright owner. Requests to reproduce material contained in this publication should be addressed to A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207, fax: 703-528-1736. For subscription information and customer service, call 1-800-572-2797. Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Meyerowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, smeyerow@optonline. net, 631.331.3908 (phone) / 631.331.3664 (fax). Material for publication is welcomed — articles, decisions, or other items of interest to bankers, officers of financial institutions, and their attorneys. This publication is designed to be accurate and authoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns reflect only the present considerations and views of the authors and do not necessarily reflect those of the firms or organizations with which they are affiliated, any of the former or present clients of the authors or their firms or organizations, or the editors or publisher. POSTMASTER: Send address changes to The Banking Law Journal, A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC 20005-2207.
Implications for Commercial Organizations of the Global Investigations into LIBOR Christine A. Edwards, Patrick M. Hardiman, Michael Madden, and Justin McClelland
The ubiquitous benchmark interest rate applied across commercial contracts, LIBOR (the London Inter Bank Offer Rate), has made the headlines globally for all the wrong reasons. This article explains what the rate is; how it is calculated; the nature of the ongoing global investigations; and how the investigations and their outcomes might affect businesses around the world.
L
IBOR is the predominant benchmark interest rate used in commercial agreements globally. Whilst definitive figures are impossible to assess, the figures suggested for the value of products tied to LIBOR globally vary from US$350 trillion to US$800 trillion. These products range from domestic mortgages through over-the-counter products, such as swaps, through to exchange-traded products, such as futures. LIBOR is also routinely used as the benchmark interest rate applicable in commercial agreements where interest is to be calculated on payments to be made between the parties.
How is it Calculated? The LIBOR is calculated daily in London by the British Bankers’ Association (“BBA”) for 10 currencies across 15 tenors (i.e., periods of time The authors, attorneys with Winston & Strawn LLP, can be reached at
[email protected],
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[email protected], respectively.
831 Published by A.S. Pratt in the October 2012 issue of The Banking Law Journal. Copyright © 2012 THOMPSON MEDIA GROUP LLC. 1-800-572-2797.
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or maturities, e.g., three month US Dollar LIBOR). The calculation of the rate is made from the submissions of banks selected by the BBA (the “Panel Banks”). Given that each Panel is selected in light of its experience in trading in the particular currency, the composition of the Panels changes for each currency. The current Panel Banks for each of the 10 currencies are to be found at http://www.bbalibor.com/panels. Each Panel Bank is required to submit a rate each day at 11:00 a.m. (London time) based on its assessment of the following test:
The rate at which an individual contributor panel bank could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size, just prior to 11:00 a.m. London time.
It is therefore not necessarily based on actual rates agreed in transactions but instead on an assessment of likely rates. The BBA takes the submitted rates, discounts the upper and lower quartiles, and averages out the middle two quartiles to produce the daily rate for each currency and tenor. It then publishes the calculated rate each day at 11.30 a.m. (London). It also publishes the rates submitted by each Panel Bank.
What are the Allegations? The allegations against certain of the Panel Banks centre on the process of submitting rates to the BBA. Certain of the Panel Banks are accused of having submitted figures that were artificially high or low and intended either: (i) to avoid a bank being perceived as having a low credit rating during the febrile financial period from 2008 onwards (i.e., the higher the submitted rate, the higher the perceived credit risk that Panel Bank represented); or (ii) to benefit the trading positions of individual traders within certain Panel Banks. To date, while investigations are reported to have been ongoing for some time internationally, only Barclays has been fined by U.S. and U.K. regulators, 832
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although Citibank and UBS have been penalized by the Japanese regulator for TIBOR (the Tokyo Inter Bank Offer Rate, a Japanese benchmark rate loosely related to LIBOR in respect of the Japanese Yen currency) irregularities. The allegations are being investigated by a number of regulators worldwide, including the U.S. Commodity Futures Exchange Commission, the U.S. Department of Justice, the U.S. Securities and Exchange Commission, the UK Financial Services Authority, the European Commission, and the Japanese Financial Services Authority.
What are the Issues? There are several key issues that arise from the allegations which have been made public: What was the impact (if any) of the alleged manipulation on the LIBOR? The impact (if any) of the alleged manipulation will likely be difficult to assess given the variables involved. Further, as the BBA itself notes, “The decision to trim the bottom and top quartiles in the calculation was taken to exclude outliers from the final calculation. By doing this, it is out of the control of any individual panel contributor to influence the calculation and affect the bbalibor quote.” To date the only details to have emerged publicly (of the manipulation alleged to have taken place) relate to Barclays. Litigation has been commenced in the U.S. and, more recently, in the U.K. in respect of both over-the-counter products and exchange-traded products affected by LIBOR. The claims range from anti-competitive (i.e., cartel) behavior to allegations of breach of contract. However, the information underpinning those claims relies in large part on media reports with attempts being made to secure disclosure from Panel Banks. Further, whilst several claims existed prior to the announcement of Barclays being penalized, there has been an increase in such claims (including class claims in the U.S.) following the announcement. Absent a fuller understanding of the entirety of the alleged manipulative behavior, it is only possible to speculate as to whether (and, if so, to what extent) the LIBORs have been influenced by that behavior. Certainly, the 833
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comments of the regulators do not provide consistent or definitive views on this issue:
The FSA (in its Final Notice regarding Barclays) appears to have avoided any definitive comment on a direct link between the behavior identified and the LIBOR. It stated (paragraph 207):
LIBOR and EURIBOR…have a wider impact on other markets. Barclays’ misconduct could have caused serious harm to participants in any of these markets. Harm could have been caused by Barclays’ misconduct if the final reference rates were affected by Barclays’ actions on any given day. Barclays’ misconduct also created the risk that the integrity of LIBOR and EURIBOR would be called into question and that confidence in or the stability of the UK financial system would be threatened.” (emphasis added)
The U.S. Department of Justice noted (in its Press Release dated 27 June 2012): “Because mortgages, student loans, financial derivatives, and other financial products rely on LIBOR and EURIBOR as reference rates, the manipulation of submissions used to calculate those rates can have significant negative effects on consumers and financial markets worldwide.” (emphasis added)
The U.S. Commodity Futures Trading Commission’s Order noted (in its Press Release dated 27 June 2012) that its “Order finds that Barclays attempted to manipulate interest rates and made related false reports to benefit its derivatives trading positions.” (emphasis added)
Calculation of Losses If any losses have been caused by the alleged manipulation, how will they be calculated? The calculation of any losses will be a complicated process, determined in large part by the applicable principles in the jurisdiction in which the claim arises. Assuming that it can be shown that any manipulation had an effect on the published LIBOR, the amount of any loss to be compensated may be reduced by any profits gained. For example, given the propensity of trading organizations to hedge their positions, where a counterparty to a swap
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Global Investigations Into LIBOR
trade lost as a result of an artificially high LIBOR, it may also have gained in any hedged transactions that settled on that same date. Will LIBOR survive? There are a number of dimensions to this question not least of which is the political dimension. The Bank of England has indicated that a review of LIBOR is necessary and has called on representatives from key central banks to discuss options at a meeting on 9 September 2012 in Basel, Switzerland. Further, the BBA has recognized the need to bolster the credibility of LIBOR. On 28 June 2012 it stated “The current LIBOR review, with which our authorities are fully engaged, has been underway since March this year and is considering all aspects including the setting process. As part of this review we will now be asking the authorities to consider in what manner the LIBOR setting mechanism should be regulated in the future.” What are the alternatives to LIBOR? Whilst LIBOR is generally recognized as the pre-eminent benchmark rate in commercial agreements, there are other benchmark rates which are used. Notable amongst those alternative benchmark rates are: TIBOR, EURIBOR (Euro Interbank Offered Rate), USD EURIBOR (U.S. Dollar Interbank Offered Rate), Eonia (Euro Overnight Index Average) and the Eonia Swap Index. It would be possible (depending on the currency involved) for parties to tie payment provisions within agreements to these alternative mechanisms.
What do Organizations Need to Bear in Mind? There are several practical matters which arise from the matters being investigated. Substitute Benchmark What benchmark interest rate should be included in agreements currently being drafted and, if LIBOR is being used, should a substitute be provided
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in case LIBOR ceases to exist? Although the Bank of England has called for consideration of the future of LIBOR, there is no current suggestion that it will be discontinued as a benchmark. Indeed, such is the current stance of the BBA and the global reliance on the benchmark that its disappearance overnight seems unlikely. However, parties to new contracts will wish to provide for certainty in their arrangements and cater for the possibility of LIBOR ceasing to exist. This could be achieved without too much difficulty by inserting a mechanism for the adoption of a substitute benchmark either immediately or in certain circumstances. Existing Contracts What if anything should be done to existing contracts that rely on LIBOR to calculate interest? Whether the future of LIBOR is at real risk remains uncertain. In respect of existing contracts, there is, therefore, a balance to be drawn between re-opening contractual arrangements now by renegotiating the applicable benchmark interest rate (with the potential for unintended consequences with other contractual terms being revisited) and the desire for certainty by jumping from LIBOR at this point. The appropriate course of action for particular parties will inevitably turn on their own circumstances. Differences in Rates? Could the attempted manipulation that has been identified so far have caused any significant differences in applicable interest rates? As with the determination of whether the alleged manipulation has had an impact on the LIBOR, much more information will need to emerge before any meaningful assessment of any impact on the LIBOR can be made. The BBA considers that the LIBOR has been insulated from such manipulation but a proper analysis of all the evidence would be needed to test that assertion. Can Payments Be Adjusted? Is there any way to adjust payments already received or paid as between parties to commercial arrangements using incorrect LIBORs, given the al836
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legations that the LIBOR has been manipulated? Whether there are grounds to revisit LIBOR already applied in the context of commercial arrangements will turn on a number of factors, including the impact of any manipulation on the LIBOR themselves (see comments above) and the time at which the incorrect rates were applied (re any applicable limitation periods).
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