Tom Hayes is a former trader from the UK who is known for playing a crucial role in the London Interbank Offered Rate (LIBOR) manipulation case. Today, let’s review this world-shaking interest rate fraud case.
The Origin and Development of the London Interbank Offered Rate (Libor).
London Interbank Offered Rate (Libor)
In the late 1960s, Greek banker Minos Zombanakis was known as one of the few international financiers who opened up cross-border lending in the global market for the first time since 1929. He adopted a novel approach by lending large sums of money to companies and countries that wanted to borrow US dollars while avoiding the strict scrutiny of the US financial system. The loan given to Iran became the first loan with a variable interest rate in history, which also marked the birth of the Libor rate.
The London interbank offered rate (Libor) is adjusted and determined by a committee elected internally by the world’s largest banks and exercising self-management. It is a rate that measures the amount of funds that need to be paid for interbank lending.
The British Bankers’ Association (BBA), established in 1919, is a lobbying organization established to safeguard the interests of British financial companies. In 1986, the BBA reached an agreement with the Bank of England to determine the BBA Libor in pounds, US dollars, and Japanese yen (later gradually increasing varieties).
In the 1990s, Libor was incorporated into the financial system as a benchmark for everything from mortgages and student loans to interest rate swaps.
In 1997, the Chicago Mercantile Exchange (CME) also began to use Libor as the reference rate for Eurodollar futures contracts.
The BBA set up a bank panel that would ask for quotes from various banks every day. To improve the calculation formula, the highest and lowest quotes would be excluded. Every morning, each bank member had to submit an interest rate estimate, from which an average value was calculated and then announced at noon. Different maturities would be calculated for different currencies. There is a Libor for each currency; the maturities are divided into 15 varieties such as overnight, 1 week, 2 weeks, 1 month, and each calendar month.
It is generally believed that this rate is almost impossible to manipulate without widespread collusion. Historically, the people responsible for submitting estimated interest rates at each bank have used the interbank money market as a reference. Banks borrow cash from each other through this market to maintain their daily operations. As market participants, they are all clear about each other’s lending rates. However, as a regulatory agency, the BBA has no power of punishment and theoretically cannot sanction false behavior.
In addition, the Foreign Exchange and Money Markets Committee (FXMMC) is the actual power holder of the BBA. It is composed of 15 representatives from Libor member banks and exercises voting rights on all matters related to Libor. However, the meeting methods and composition of members are not made public, nor are the meeting discussions and resolutions disclosed. Even if a bank is found to have violated Libor regulations, the power of punishment belongs to the FXMMC.
Banks and investors use the Libor rate as a reference rate for financial contracts for a fee. This fee is a stable and important source of income for the BBA.
The Aggressive Trader and the Libor Manipulation Saga
Tom Hayes was born in 1979 and studied at The University of Nottingham. In 2001, after graduating, he entered the Royal Bank of Scotland (RBS). When he started, he was a clerk in the interest rate derivatives department and soon began to be responsible for small trading accounts. Although his trading had equal shares of failures and successes, he showed his ability to manage risk fluctuations. In 2004, he joined the Royal Bank of Canada (RBC). During this period, he designed a business platform suitable for changes in portfolio assets to monitor changes in risks, losses, and exposures in real time.
In 2006, Tom Hayes joined Union Bank of Switzerland (UBS) and worked in Tokyo. In every place he worked, he set up his own software so that he could accurately observe positions and asset changes at any time.
Tom Hayes has always been overly obsessed with the financial market. He wakes up before dawn every day and turns on his mobile phone to see what has happened in the market during his sleep. He also pays attention to data on his way to the office. Before reaching his destination, he has collected a large amount of information that can be used to predict short-term interest rate changes and has initially formed his trading strategy for the day. After contacting brokers by phone, he will be in a fanatical state of high concentration for the next eight hours. During trading hours, there are no meetings or lunch breaks. The only breaks are five minutes in the restroom or going to the internal coffee bar.
All of Tom Hayes’ business interactions during working hours are concise. To save time, each sentence has very few words and vowels are removed from the text information. There are hundreds of conversations every day, almost all completed within 20 seconds. Most of the time at night he goes home, but he is still constantly looking at his mobile phone. His market views have become relatively short-sighted. It is also difficult to relax on weekends. These have led to Tom Hayes being emotionally impatient and indifferent to worldly affairs. A trader is his profession and hobby, his social life and identity. There is no other space except focusing on accumulating funds and avoiding losses.
There are two types of players in poker. One is the nervous type. These people wait for the best hand and then place large bets, hoping to make a big profit. The other is the aggressive type. These people can’t help but bet on every card in their hand, stimulate their opponents and scare nervous opponents so that they dare not play cards. Tom Hayes belongs to the latter. He is constantly trading. While trading, he collects useful information and collects market-making commissions, creating an image of high trading volume and high risk tolerance. Tom Hayes believes that trading is a process of lonely pursuit, a process of one person fighting the whole world. He regards systems and models as second nature and shares his passion for financial markets and economics. When encountering things, the first thing he thinks about is where the advantage is, how to make more money, how to break through boundaries, and even pay attention to some gray areas to expand advantages.
Tom Hayes trades thousands of varieties, such as interest rate swaps, forward rate agreements, basis swaps, and overnight index swaps. The common point is that the value of each variety fluctuates up and down under the influence of the reference base point of interest rates, especially the influence of Libor. The contract value of each basis point is about 750,000 US dollars. He mainly focuses on the mainstream trading tools of the Japanese yen for three months and six months, focusing on the changing trend of spreads within different maturities, finding price anomalies and making spreads. This belongs to relative value trading. Every time he trades, Tom Hayes decides whether to hedge the risk of his position through derivatives.
Tom Hayes quickly became the largest and most aggressive trader in the yen market. And he began to be responsible for the open positions of the entire team on the benchmark interest rate, changing from an individual’s sporadic activities to organized activities. Due to his trading volume being much larger than the combined scale of those competitors, opponents from other banks do not want to go against him. At that time, the largest yen derivatives trading was carried out in Tokyo but had almost no connection with London, which was responsible for setting interest rates. Tom Hayes gradually began to claim that he could influence the trend of Libor and could ask the yen Libor to change in the direction he wanted.
Generally speaking, if several major banks submit lower interest rates continuously for several days, other banks will start to imitate, thinking that competitors may know more about the cash market situation. According to this trend, the interest rate will soon change by several basis points. Tom Hayes will try to get to know more colleagues as much as possible, especially by focusing on tracking traders who make the final quotes every day through various relationships. This can also be regarded as a work skill.
Perhaps due to his background, Tom Hayes has more in common with most brokers from the working class. The job of a broker is to match buy and sell orders and does not require complex mathematical skills like trading derivatives. Cultivating long-term cooperative relationships with customers is instead more important.
Brokers are divided into two types: one is technical, who understands the trading situation of customers and can quickly make their trades profitable; the other is relationship-oriented, who does not understand technology but has good information channels. Brokers are intermediaries in the financial market and assist different banks in completing various transactions. Almost any cash and derivatives transaction is completed through brokers.
In the relatively ambiguous over-the-counter derivatives market, since there is no central exchange, brokers are the central link of information flow. Although brokers are not responsible for setting Libor, people in banks who are responsible for setting interest rates rely on brokers to understand cash trading situations. The relationship between traders and brokers is symbolic and very unequal. The latter’s salary is much lower than that of the former and mainly depends on commission income, which gives traders with large trading volumes a great negotiating advantage. Tom Hayes precisely has this advantage.
Intercapital (ICAP), the world’s largest broker, was founded in 1986 and has about 5,000 employees. The founder, Michael Spencer, is a friend of former Prime Minister David Cameron. Every year, he holds charity days for celebrities and royals among his clients. What attracts Tom Hayes the most about this company is that ICAP sends out an informal but closely monitored email predicting Libor values every morning. Recipients include traders, brokers, and 13 yen Libor setters from 16 banks.
Tom Hayes has always maintained close contacts with many brokers, especially brokers from large brokers like ICAP. He even pays trading commissions to familiar brokers through false transactions. The purpose is simple, that is, to hope that brokers or other traders that brokers can influence will provide convenience in manipulating Libor.
In fact, Tom Hayes is never sure how much influence he will have on Libor. Although this interest rate often runs in the direction he wants, he cannot know whether it is the result of private communication efforts or just luck. He estimates that the revenue from Libor changes accounts for only 5-10% of his total revenue. In 2007, he made a profit of 50 million US dollars for UBS.
From the summer of 2006 to September 2009, in the 570 days he worked at UBS, Tom Hayes and his colleagues made more than 2,000 documented requests. Three-quarters of the time, they tried to manipulate Libor and there was almost no disguise.
The CFTC and the Libor Manipulation Scandal: Challenges and Controversies.
The Commodity Futures Trading Commission (CFTC) of the United States was established in 1975 and mainly supervises the futures and options markets.
The competent department is the Committee on Agriculture, Nutrition and Forestry. Elected officials have traditionally come from rural areas and agricultural markets. The CFTC shoulders a broad responsibility for intervening in financial markets. However, complex financial cases and anything related to Wall Street are tacitly assumed to be the functions of the U.S. Securities and Exchange Commission (SEC), the Federal Reserve System (Fed), and the Office of the Comptroller of Currency (OCC). As a civil agency, the CFTC cannot impose criminal sanctions on illegal individuals or enterprises.
Like all law enforcement agencies, the CFTC also looks for clues of potential financial fraud in news reports. On April 16, 2008, the front-page headline of The Wall Street Journal was “Bankers Doubt the Benchmark Interest Rate in Crisis”, reporting that many large banks intentionally lowered their expected borrowing costs to hide their thirst for cash from the market; this behavior distorted Libor. During the subprime mortgage crisis, considering risk control and potential risk exposure, banks strived to make their submitted borrowing rate quotes as close as possible to the intermediate rate rather than the actual required interest rate value to obtain liquid funds for balance sheet matching. The government also judges which banks need government rescue based on the interest rate quotes of each bank. Libor fraud not only causes losses to banks due to interest rate inversion but also has an impact on borrowing rates and derivative payment products; the prices of Libor and CDS always change synchronously, and indeed the two have begun to deviate since 2008.
In the more than four years starting from the end of 2002, the CFTC has punished more than 20 U.S. energy companies for falsifying the benchmark price of the natural gas market; this is very similar in nature to manipulating Libor. Although there is great controversy over jurisdiction, ultimately, because the CME widely uses Libor and the CME is within the jurisdiction of the CFTC, the CFTC feels it has the right to investigate Libor. Until the summer of 2009, the CFTC did not obtain any valuable information from any bank.
At the end of 2009, with the help of a former employee who is now working in a law firm, the CFTC obtained a large amount of internal monitoring and investigation materials of Barclays Bank; proving that not only internal teams but even the Bank of England, out of their own economic interests or national interests, have explicitly intervened in the US dollar Libor rate. However, how to handle it judicially has become a contradictory issue, especially involving the Bank of England; low interest rates are still an indispensable important factor in the financial environment at that time, and avoiding negative impacts on the global economy is also extremely crucial.
In fact, shortly after the media reported publicly, the Bank of England did not exercise its regulatory power over Libor nor take responsibility for it. The Financial Services Authority (FSA) also did not launch an investigation into improper behavior. Considering the potential political impact, in 2013, the FSA had to launch an investigation.
The case of Barclays Bank manipulating Libor, including examining 2,200 documents, interviewing 75 people, and listening to more than 1 million voice recordings. Considering the labor and lawyer fees involved, the total cost reached 100 million pounds. This is unaffordable for any government agency. After all, similar events are just the daily work of regulatory departments. Regulatory departments can only order problem banks to entrust law firms to conduct internal investigations, and banks pay the investigation fees; and the entrusted law firms are mostly business partners who have maintained long-term cooperative relationships with banks. Regulatory departments also have no objections to this arrangement.
Barclays, ICAP, and the Conviction of Tom Hayes.
In June 27, 2012, Barclays Bank became the first bank to reach an agreement with global regulatory agencies. It agreed to pay a fine of 290 million pounds and was exempted from criminal prosecution. A week later, CEO Bob Diamond was forced to resign. However, this case led by the CFTC and the U.S. Department of Justice (DOJ) failed to generate much reaction in the American public opinion and political circles. In 2013, ICAP was fined 54 million pounds for assisting in manipulation. But the person who sent emails at ICAP explained during the trial that he admitted that he would sometimes orally agree to modify the email content, but in fact he had never done it.
In September 2013, the BBA was deprived of its Libor regulatory authority and received condemnation. Its functions were handed over to a subsidiary of the New York Stock Exchange (NYSE). And a legal provision was added to confirm that attempting to manipulate Libor or other financial benchmarks is an independent criminal offense.
The CFTC reached an agreement through the Swiss Financial Market Supervisory Authority (Finma). UBS submitted relevant documents to the United States through Finma, avoiding privacy protection laws. UBS admitted all the problems and indirectly provided all the evidence of Tom Hayes’ crime. In mid-December 2012, Tom Hayes began to be questioned in the UK. Soon, he changed his legal team due to expensive costs.
At the end of March 2013, to avoid being extradited to the United States for trial, Tom Hayes reached a plea agreement with the SFO. In early 2015, he was diagnosed with Asperger syndrome. Eighteen months after his arrest, Tom Hayes was tried on May 26 and was finally sentenced to 11 years in prison and had to repay 878,806 pounds of criminal proceeds. According to British law, the imprisonment time will not exceed six years. In this case involving more than twenty people’s crimes, Tom Hayes is the only individual convicted.
Distorted Behavioral Boundaries
“The Fix: How Bankers Lied, Cheated and Colluded to Rig the World’s Most Important Number”, Authors: Liam Vaughan and Gavin Finch. The original book was published in 2017. This book details the whole story of the interest rate fraud case. Finally, let’s use a quote from the book as the concluding remark.
Reproduction Notes：InvestFancy » Tom Hayes:World-Shaking Interest Rate Fraud Case