LIBOR- Too Big To Litigate?

Libor Manipulation Litigation – Hard to know if it’s dead on arrival or a slumbering giant

by James Frischling, President, NewOak and Ron D’Vari, CEO, NewOak

NewOak provides Strategic Consulting, Valuation, Analytics and Litigation Support to Global Banks, Asset Managers, Financial Institutions and Law Firms.

The Libor manipulation scandal, when discovered, was going to make the residential mortgage fight look small. Given the size, magnitude and number of asset classes and investors affected, this looked like the big one for the financial and legal community.

However, all seems relatively quiet on the Libor litigation front thus far. A number of banks have paid billions in fines and admitted wrongdoing to settle with the government and put the Libor investigation behind them. The banks even received a big victory from the Federal District Court in Manhattan when the bulk of the claims filed against them by private plaintiffs were dismissed.

So has the Libor manipulation fight been over-hyped? Not by a long-shot.

The Libor scandal isn’t too big to litigate as some have suggested. It represents a systemic problem in the financial markets and, as a result, will need to work its way through the system and courts. The first round of complaints was essentially consolidated into a single multidistrict litigation. Now that the U.S. District Court judge shot down the majority of those claims, some plaintiffs have narrowed their arguments and already filed new complaints. There are also many other parties taking a wait-and-see approach to the initial cases before pursuing their own litigation.

One of the challenges to the Libor manipulation scandal is calculating the impact on the plaintiff’s positions. While the artificially low Libor rate cost investors on the asset side of their balance sheet, it benefited them on the liability side. Netting the impact of the manipulation on the plaintiffs is no small task and each plaintiff will need to make those calculations before heading to court. There is no argument that Libor was manipulated, but determining whether a plaintiff was damaged as a result—and to what extent—is a different story.

Eurozone Single Supervisory Mechanism (SSM): The Promise of Sufficient Transparency?

While the artificially low Libor rate cost investors on the asset side of their balance sheet, it benefited them on the liability side. Netting the impact of the manipulation on the plaintiffs is no small task

Daniele Nouy, the newly elected head of the Eurozone’s Single Supervisory Mechanism (SSM), has expressed in her first interview with the Financial Times that the SSM will take a firm approach and consider letting the weaker banks die. Nouy considers the willingness to pursue and implement a credible Single Resolution Mechanism (SRM) to be a cornerstone of the Eurozone banking system.

Nouy thinks the Eurozone banks are in much better shape now than they were in 2008. The banks have added over 4% to their capital ratios on average since the onset of the credit crisis. However, according to the FT interview with Nouy, there are still important concerns about bank transparency in the Eurozone:

“I think the problem that we are facing is probably insufficient transparency regarding the balance sheets of the European banks. This is why we are conducting this comprehensive assessment to increase significantly the level of transparency, to repair balance sheets when there is a need for repairing balance sheets, and to restore confidence.”

As part of its comprehensive assessment process, the SSM plans to focus on the riskiest parts of portfolios such as commercial and residential real estate, shipping assets, and other opaque instruments. An educated approach to sovereign risk and size limits will also be required. A zero-sovereign-risk approach will be considered a red flag.

A long list of challenges for SSM will include qualified credit/risk staffing as well as how to work collaboratively with national supervisory authorities across the Eurozone. SSM active engagement and debate with U.K. authorities and other non-SSM voices, as well as the European Banking Authority, will be critical to developing a single market.

According to the Nouy interview, SSM has already received and is currently reviewing various national authorities’ plans for certain portfolios and intends to challenge the extent and depth of these reviews for proper identification and consideration of risks.

While national banking authorities are expected to enforce local laws, the ECB and SSM will be empowered to impose proportionate and dissuasive penalties for breaches of supervisory rules and decisions, as well as infringements of European law. However, despite all the good intentions, the implementation of a Eurozone bank transparency process likely will take more time than expected, but it is a journey well under way.