The Parliamentary Review: Review of the Year in Finance

By Ian Fraser

Published: The Parliamentary Review

Date: September 30th, 2013

The Libor scandal

Image: William Banzai 7

Image: William Banzai 7

It was described as the banking industry’s ‘tobacco moment’.

In June last year, Barclays was fined £290 million by US and UK regulators and judicial authorities after it admitted to systematically rigging the London Inter-Bank Offered Rate (Libor). Libor is the global benchmark interest rate that effectively sets the price of money. It is used to value more than $360 trillion worth of loans and derivatives around the world. Confirmation that Barclays had sought to falsify this rate for pecuniary gain and to deceive investors was a massive bombshell, and got people wondering if this sort of market manipulation might be endemic in finance. After a series of earlier scandals at the bank, some involving ‘aggressive’ tax-avoidance schemes, others the mis-selling of payment protection insurance and swaps to small businesses, the Libor issue severely dented Barclays’ reputation.

Within months the Financial Services Authority (FSA), US Commodities Futures Trading Commission and US Department of Justice also found that traders at the Royal Bank of Scotland Group and UBS had been falsifying Libor in collusion with other bankers, and profiting from skewed derivative trades. Barclays also admitted to ‘lowballing’ its Libor submissions in 2007–09 in order to deceive investors about its own financial strength. The episode was hugely damaging for all three banks but particularly so for Barclays – partly because it was the first out of the blocks in reaching a settlement. Within days of the 27 June announcement, Barclays Chief Executive Bob Diamond, Chair Marcus Agius, Chief Operating Officer Jerry del Missier, and Non‑Executive Director Alison Carnwath had all been forced out or had resigned.

John Griffith-Jones, Chair of the Financial Conduct Authority, which took over some of the functions of the FSA in April and continues to regulate Libor, said ‘don’t underestimate the damage that Libor has done to the City of London’. Speaking at the Chartered Institute of Securities and Investment conference on 3 July, he added: ‘It is difficult to put into words just how far, and how fast, confidence has dissipated in financial services.’ The comparison with the tobacco industry was made last year by the unnamed chief executive of a multinational bank, quoted by The Economist. He was referring to the lawsuits and settlements that cost America’s tobacco industry more than $200 billion in 1998 and permanently trashed that industry’s reputation. The Libor scandal still has much further to run.

Other UK-based banks, including HSBC and Lloyds Banking Group (the parent, since January 2009, of HBOS), are being probed by regulators and could also be hit with stiff fines and other penalties. A number of individual traders and brokers are facing criminal prosecutions, while all the banks involved are subject to, still incomplete, probes by the anti-trust authorities in Canada, Switzerland, the EU and Japan, and also face potentially crippling multi-billion lawsuits from investors, including pension funds and American municipalities which allege they lost billions as a result of Libor falsification by between 16 and 20 banks. Altogether, analysts expect the scandal is likely to cost British banks tens of billions in the coming years, and possibly as much as £80 billion.

Read my full in-depth report on the financial services sector in September 2012 – September 2013, on The Parliamentary Review website

Kweku and the scandals

Kweku Adoboli, an equity derivatives trader at Swiss bank UBS, amassed more than $8 billion in unauthorised positions on equity index futures and then hid them using fake hedges. The reputation of British banking was further tarnished when in summer 2012 both HSBC and Standard Chartered were heavily fined by the US Department of Justice for the criminal money laundering of the ill-gotten gains of Mexican drugs cartels and for masking transactions for pariah states including Iran. And all the leading banks were involved in the mis-selling of payment‑protection insurance, which artificially inflated their profits in the 2000s and is costing them £18 billion in recompense to consumers who were effectively swindled. That is twice the £9 billion cost of the London Olympics.

And the banking scandals just kept coming. In July, Barclays and four of its former traders were penalised with $488 million in fines and penalties, by the US Federal Energy Regulatory Commission for Enron‑style manipulation of American energy markets. The bank, which is disputing the claims, is also required to give up $34.9 million in profits, to be distributed to programmes that help low-income homeowners pay energy bills. Other scandals are brewing. The Royal Bank of Scotland (RBS) is expected to be fined hundreds of millions of dollars by the US Department of Justice for alleged money laundering for proscribed regimes by its US subsidiary Citizens Financial.

Regulators are also weighing up whether to probe what is believed to be rampant manipulation of the $4.7 trillion per day foreign exchange market. Reports suggest that, for at least a decade, leading banks have been ‘front-running’ client orders and distorting the WM/Reuters spot rates. The European Commission is also probing a number of oil companies and financial firms for alleged manipulation of the $3.4 trillion a year crude‑oil market. US regulators are also investigating the alleged industrial‑scale rigging of the ISDAfix rate, a benchmark used for the swaps market, by 16 banks including RBS. ISDAfix is used by pension funds to hedge portfolio risks and by most companies or users of fixed-income derivatives. New York-based financial consultant Jack Chen told Bloomberg News: ‘In three years, ISDAfix will be the bigger story, and could be potentially bigger than Libor in terms of damages.’

After a ten-week trial which shone a harsh light on wrongdoing, recklessness and greed in the City of London, Kweku Adoboli, a former trader at Swiss bank UBS, was sentenced to seven years in prison on 20 November 2012. In what’s described as the biggest rogue trading scandal in British history, the Ghanaian-born trader, who worked on UBS’s London-based ‘Delta One’ equity derivatives desk, amassed more than $8 billion in unauthorised positions on equity index futures – and then hid them using fake hedges. During the trial, Adoboli testified that he became desensitised to the size of his trades. They were just dots on a screen. He was found guilty of two counts of fraud but innocent of four counts of false accounting. During the trial, Sasha Wass QC told jurors that Adoboli, now locked up in Verne Prison in Dorset, was ‘a gamble or two away from destroying Switzerland’s largest bank for his own gain’. In the end he lost the Swiss bank some £1.4 billion. UBS has since accepted that its risk controls and management policies were ‘seriously defective’, and agreed to pay a fine of £29.7 million to the Financial Services Authority. The Swiss regulator, FINMA, has banned UBS’s investment bank from making any acquisitions, and is keeping close tabs on the unit.

Challenge No. 1: rebuilding trust

The most serious challenges facing the financial sector – and particularly the UK banking sector – are obvious. It needs to get its ethical house in order and work towards regaining the trust of consumers. Only 3% of the delegates at the Chartered Institute of Securities and Investment 2013 conference said they believed public confidence in financial services could be restored within three years. And a survey of more than 11,000 adults reported in Public Trust in Banking by YouGov and the University of Cambridge found that only 4% of Britons believed that banks observe high ethical and moral standards. Only 17% of respondents said they trusted top bankers to tell the truth. The report said this meant bankers vie with ‘MPs, estate agents and tabloid journalists in the relegation zone of public contempt’.

Things deemed to have contributed the most to banking’s disastrous reputation were excessive bonuses (57%) and the Libor scandal (54%). Many believed banks were acting as a brake on the UK’s economic recovery. Bankers were seen as ‘greedy and untrustworthy, putting profit before people’. The primary changes that respondents would like to see are remuneration caps and greater transparency. Current or planned reforms were seen as insufficient to bring real change. Respondents said they overwhelmingly supported penalising the banks more, over and above any concern that greater regulation might damage the wider economy through lost jobs or lost tax revenue. Only 13% said they would be proud to work for a bank, while just 13% said British banks provided high-quality products, 13% said they improved people’s lives, and only 9% believed they were financially sound. Only 6% saw them as trustworthy, with 4% saying they had high ethical and moral standards.

‘It is no surprise that banking is rated poorly across the YouGov scorecard of 26 industries. The image of greed and illegality at a time of austerity could hardly be worse,’ said YouGov’s Stephan Shakespeare.

M&A muted but reviving

Most of the significant deals in the past year have been driven by large banks and insurers making disposals, with the UK’s largest insurer, Aviva, being a case in point.

Mergers and acquisition activity in the financial sector is much more muted than during the credit bubble years of 2003–07, when the Royal Bank of Scotland (RBS), Santander and Fortis bought the Dutch bank ABN Amro in a hubristic and self‑destructive €72 billion deal. Most of the significant deals in the past year have been driven by large banks and insurers making disposals, often as a result of regulatory pressure or the need to strengthen their capital positions, or both. A string of recent disposals by the UK’s largest insurer, Aviva, is a case in point. As it exits a string of international markets, since September 2012 Aviva has sold its US business for £1.2 billion, its stake in Amsterdam‑based insurer Delta Lloyd for £671 million, its stake in a Malaysian joint venture for £152 million and its Turkish subsidiary Aviva Sigorta for £269 million. Chief Executive Mark Wilson, who was appointed in November 2012, said his goals are to ‘simplify’ the business and reduce its leverage.

RBS is also in the process of retrenching back to the UK market in the wake of its near collapse in 2008–09. Its Direct Line Insurance division is being sold to stock-market investors, with nearly one-third of the general insurer’s equity floated on the stock market on 11 October 2012. The price suggested the whole of Direct Line, which includes Churchill, Privilege and Green Flag, could fetch £2.6 billion to £3 billion. Outgoing RBS Finance Director Bruce Van Saun is confident that RBS can offload its remaining 67% stake by December 2014. As part of the state-aid remedies agreed with the European Commission, RBS undertook to sell off 318 of its UK branches by December 2013. It was going to sell the branches – which employ 5500 staff, have 1.8 million retail customers and £21.7 billion in deposits – to Madrid‑based Santander for £1.65 billion. But in October 2012, Santander pulled out. RBS has since changed tack, saying it will float the assets off as a separate listed entity under the relaunched brand name Williams & Glyn’s.

Lloyds Banking Group had a similar set back in April 2013. It must sell 632 former TSB branches to satisfy the EU, and had lined up a deal with Co-operative Bank. But this collapsed after Co-op discovered a £1.5 billion capital shortfall on its balance sheet. Lloyds also said it would go down the flotation route, and in September relaunched the TSB brand with a £30 million advertising campaign to differentiate the carved‑out branches. However, both RBS and Lloyds are going to miss the EU’s December 2013 deadline for enforced disposals. Lloyds did sell a 15% stake in its wealth management arm St James Place for £450 million, its half stake in Sainsbury’s Bank for £248 million and its international private banking operations to Geneva‑based Union Bancaire Privee for £100 million. It also sold its retail banking operations in Spain to Banco Sabadell, and a portfolio of residential mortgage‑backed securities (RMBS) for £3.3 billion.

Other mergers and acquisitions in the past year included Royal London’s £219 billion acquisition of Co‑operative Life insurance, a deal Co-op did as part of its scramble for capital. Another was insurer Legal & General’s acquisition of the annuity company Lucida for £151 million. The expansionist asset-management group Blackrock bought Credit Suisse’s exchange-traded funds business, which has $8.1 billion under management for an undisclosed sum; the business will be merged into BlackRock’s iShares business, giving it an astonishing 82% share of the physical exchange‑traded fund (ETF) market. In February 2013, Aberdeen Asset Management took its assets under management above £200 billion with the acquisition of New York‑based fixed-income fund manager Artio Global for $175 million and a 50.1% stake in private equity fund-of-funds SVG Advisers for £17.5 million. In May 2013, the US-based debanagement and recovery firm Encore Capital bought the UK- and Ireland-focused debt‑management firm Cabot Financial for £427 million from private equity investor JC Flowers.

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