The LIBOR affair and local authorities

Assets iStock 000005516576XSmall 146x219The revelations over LIBOR have dominated the front pages in recent weeks. But what are the potential consequences for local authorities? Emily Heard, Peter Keith-Lucas and Patrick Holmes explain.

The unfolding news story regarding the attempt by Barclays to manipulate the LIBOR could have far reaching consequences for local authorities. Any substantial deposits held, and/or transactions carried out, between 2005 and 2009 and linked to LIBOR, should be reviewed if the FSA discover that LIBOR was artificially changed by Barclays and a number of other banks under investigation. We now await the outcome of the FSA’s investigations into the other banks on the LIBOR panel.

Background

Bank Rate and the London Interbank Offered Rate (LIBOR) are the two principal daily reference rates for interest rates. The Bank Rate is set daily by the Bank of England and is the rate at which the Bank of England will borrow money. It is then used as the basis for calculating PWLB rate (at which local authorities borrow most of their long-term borrowing). In contrast, LIBOR is set by the commercial banks stating the rates of interest at which they are prepared to lend short-term funds to each other in different currencies. LIBOR is therefore composite of the current lending rates between the main commercial banks (including Barclays).

More importantly, LIBOR is also the benchmark for pricing some savings, UK residential mortgages, commercial mortgages, and increasingly for pricing commercial loans by banks to UK businesses. The LIBOR directly affects the funding costs of commercial businesses in their transactions with public bodies, for example in funding PFI transactions where the borrowing is undertaken by the contractor rather than by the public body.

On 28 June 2012, an FSA Report revealed that Barclays plc (or more specifically its investment banking arm, Barclays Capital or "BarCap") had been engaged in manipulating the LIBOR.  Barclays’ traders conspired with ex-employees working at other banks to try to influence what those banks published each day as the rates at which they would lend money to other banks on LIBOR.

Barclays’ attempts to manipulate LIBOR are reported as having had two distinct objectives. Where Barclays had entered into deals to lend, they wanted to push LIBOR up, so that Barclays would recover higher interest rates from borrowers. At another stage, there was much speculation that Barclays was under-capitalised and would be vulnerable if it had to borrow money from other banks at higher interest rates. So Barclays attempted to reduce LIBOR in order to counter such concerns and make it appear to be more financially secure. The FSA found that Barclays could have benefited from their attempted manipulation, but the FSA's report stops short in confirming that Barclays succeeded in their attempts to actually change the LIBOR. Nevertheless Barclays have been fined a total of £290m, the FSA's portion of that fine is £59.5m. This relates to trading activities by BarCap which could have had the effect of artificially altering the LIBOR. 

How might it affect public sector organisations?

When LIBOR goes up, associated interest rates and monthly loan payments can also rise. It follows then that when LIBOR goes down, adjustable-rate loans could also have lower payments.

The most direct effect would be an interest rate swap. However, the Audit Commission ruled that this was ultra vires for councils to engage in as far back as 1989. The types of circumstances where it might have a knock-on effect are:

  • Financial swaps at the close of many infrastructure deals will be benchmarked on LIBOR. Many local authorities will have become involved in PFI or other funding arrangements. When the financial swap was made, it is likely that it will have been indexed to the LIBOR, thus potentially suffering an indirect loss.
  • LIBOR also influences the setting of interest rates on fixed-rate deals, although only at the margins. Barclays traders were pushing the LIBOR up at one stage, which could have pushed mortgage rates higher than they should have been. But the indications are that during the financial crisis, Barclays were attempting to manipulate LIBOR down, so that Barclays would appear to be financially stronger than it actually was. Consequently, it is arguable that private landlords with LIBOR-linked buy-to-let loans enjoyed interest rates lower than they might otherwise have had to pay.
  • Local authority long and medium term borrowing is normally from PWLB and so linked to Bank Rate rather than LIBOR.
  • Many local authorities have short-term cash balances which they will lend to banks and other financial institutions, sometimes just overnight. The interest rates for such short term lending are normally influenced by LIBOR.

What to do next

Evidence is still emerging as to the extent of Barclays’ and other banks’ activities and whether it had an effect of altering LIBOR. This will help to establish whether Barclays’ efforts actually affected LIBOR, and whether at any particular date that effect was to raise or to lower LIBOR. Only at that point will it be possible to assess whether a particular public body has gained or lost from such manipulation.

It will also be important to ascertain to what extent it affected sterling LIBOR. At the moment, the FSA has found that Barclays acted inappropriately by making US dollar LIBOR and EURIBOR submissions (not sterling LIBOR). If a transaction was completed in the United Kingdom then it is extremely likely that it will be linked to sterling LIBOR.

The starting point will be to look at any substantial deposits held, and/or transactions carried outcarried out between 2005 – 2009 that may be linked to the LIBOR. The next step is to ascertain whether the interest rate on those transactions are likely to have been affected by LIBOR increases or decreases, and if so whether an organisation is likely to have been adversely affected as a result. Royal Bank of Scotland, Lloyds, and HSBC have confirmed that they are helping the FSA with its enquiries. Aside from Barclays, a number of other banks remain under formal investigation.

The FSA are continuing their investigations into a number of other banks and we wait for a clearer idea of what the likely impact was on LIBOR. We shall be watching the emergence of this new evidence closely and the potential ramifications for our clients and the public sector as a whole. So far, the details of the LIBOR scandal suggest that this goes far beyond any one bank.

Emily Heard and Peter Keith-Lucas are partners and Patrick Holmes is a solicitor at Bevan Brittan. Emily can be contacted by This email address is being protected from spambots. You need JavaScript enabled to view it..