Sunday, December 8, 2013

1.71 BEUR Fines for Banks – Simple Settlement with EU Commission or Interest Rate Derivatives Cartel?

First the facts: Since 2008, the European Commission had investigated whether banks have illegally arranged their submissions for EURIBOR and YEN LIBOR fixings. For some of the accused banks, this investigation has ended on 4 December 2013. Deutsche Bank, Société Générale, RBS, JP Morgan, Citigroup, and RP Martin will pay 1.71 BEUR in total. Barclays and UBS pay nothing, due to EU Leniency rules.

If you compare the European Commission's with the banks' press releases, you read two different stories:

The European Commission talks about “cartels in the interest rate derivatives industry” and “collusion between competitors”. Joaquín Almunia says:

“What is shocking about the LIBOR and EURIBOR scandals in not only the manipulation of benchmarks, which are being tackled by financial regulators worldwide, but also the collusion between banks who are supposed to be competing with each other.”

Deutsche Bank writes about an “agreement” or “settlement”, it has reached with the European Commission. The bank's co-CEO's, Jürgen Fitschen and Anshu Jain, say:

“Today’s settlement marks one important step in our efforts to resolve the Bank’s legacy issues. The settlement relates to past practices of individuals which were in gross violation of Deutsche Bank’s values and beliefs. Acting with integrity is a core value at Deutsche Bank, and we expect every employee to adhere to it. We are attaching the highest institutional importance to ensuring that this type of misconduct does not happen again.”

Société Générale also writes about a “settlement” with the European Commission and emphasizes that an individual employee arranged the EURIBOR quotations with other banks, without his supervisors' knowledge and upon the initiative of a trader with another bank.

JP Morgan mentions its press release that “the settlement makes no finding that JP Morgan Chase management had any knowledge or involvement in the conduct at issue, or that the traders' actions had any impact on the firm's LIBOR submissions or the published LIBOR rates.”

The first thing you see when you look at RBS' press release is a huge picture of EU flags in front of the European Commission's building.

Should I try to link the image with the topic of the press release?

  • It's all about the Commission, not about RBS?
  • As the inclined Commission building shows, the Commission's path is not always straightforward?
  • By paying its fine, RBS participates in the European project?

I should perhaps not overstate things at this stage. Anyways, RBS doesn't talk about cartel or collusion either, it writes that “RBS has agreed to pay a settlement penalty of € 131,004,000 to resolve the investigation”.

Philip Hampton, RBS chairman, says:

“We acknowledged back in February that there were serious shortcomings in our systems and controls on this issue, but also in the integrity of a very small number of our employees. Today is another sobering reminder of those past failings and nobody should be in any doubt about how seriously we have taken this issue. The RBS board and new management team condemn the behaviour of the individuals who were involved in these activities. There is no place for it at RBS."

Cartel in the interest rate derivatives industry?

Under European Law, what is a cartel? In a cartel, competitors either explicitly agree or align their behavior. They do so to influence competition in the market. A cartel can, for example, consist of fixing prices or other trading conditions. In the view of the European Commission, this is what traders have done. By aligning their EURIBOR or Yen LIBOR quotes, they indirectly fixed prices for interest rate derivatives based on these base rates.

Today's settlement includes two cartels:

  • The Euro interest rate derivatives cartel includes Barclays, Deutsche Bank, RBS, and Société Générale. Crédit Agricole, HSBC, and JP Morgan have not yet settled with the European Commission.
  • The Yen interest rate derivatives cartel consists of UBS, RBS, Deutsche Bank, Citigroup, JP Morgan, and RP Martin.

It is important to understand that a cartel can exist even without the company as such being involved. As a matter of fact, the company remains liable for its employees, no matter if or how they were instructed by top management to lead or participate in the cartel.


The Commission assesses fines in a three step process:

  • The basic amount of the fines depends on the value of sales generated by the cartel in its last year of operation. The value of sales is multiplied with a gravity factor (between 0 and 30 %, depending on elements such as the nature of the infringement, the combined market share of all cartel participants, the geographic scope of the infringement, and the degree of its implementation) and the number of years the cartel operates. To this amount, the Commission adds additional 15 – 25 % (prevention factor) of the value of sales, independent of the gravity factor and the time of operation of the cartel.
  • The Commission then adjusts the base amount upward or downward. Aggravating factors are continuing or repeating infringements, refusal to cooperate, and the role as leader or instigator of the cartel. Mitigating factors are, above all, a proven termination of the cartel, a simply negligent participation in the cartel, and an effective cooperation with the European Commission to discover and investigate the cartel. Under the Leniency rules, the degree of any downward adjustment also depends on each participant's timing of cooperation with the Commission: The first collaborator can be either totally exempt or benefit from a 30-50 % reduction, the second collaborator can hope for a 20-30 % reduction, and any subsequent collaborator can obtain a maximum 20 % reduction.
  • Finally, for each participant, the fine is capped at 10 % of its total turnover.

The formula for calculating the fine would look like this

F = MIN (BA * AM; T * 0.1)
with BA = V * G * Y + V * P

F = Fine
BA = Basic Amount
AM = Aggravating / Mitigating Factor
T = Total Turnover in FY-1
V = Value of Sales
G = Gravity Factor
Y = Years of Infringement
P = Prevention Factor

As the banks have settled their claims, the European Commission applies a further 10 % discount.

The following basic amounts and fines have been received by the settling banks:

The European Commission has not published the exact gravity and prevention factors. Therefore, we cannot calculate the exact volume of sales generated by the cartels. Depending on the factors you choose, the Euro Interest Rate Derivatives Cartel has generated sales between 2 bn € and 6.9 bn €.

A final word on the scope of the Commission's investigations and fines: They separate from any other actions taken by financial regulators. The Commission protects competition and ensures the functioning of markets whereas regulators tackle possible manipulation of financial benchmarks. The EURIBOR / LIBOR story may not yet be finished for our banks...