Different Competitive Effects in Financial Rate-Setting Cases

 

Economists Ink: A Brief Analysis of Policy and Litigation

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View Jonathan A. Neuberger’s Profile
Stuart D. Gurrea has extensive experience in constructing and assessing economic models. His consulting experience includes calculating damages and performing financial analyses.

Jonathan A. Neuberger specializes in financial economics, valuation, and damages analysis in complex commercial litigation across a broad range of industries.

In recent years, many of the largest banks have been accused of manipulating benchmark rates. Cases concern the LIBOR rate used to set adjustable mortgages and other financial products (In re LIBOR-Based Fin. Instr. Antitrust Litig., 935 F. Supp. 2d 666 (S.D.N.Y. 2013)), foreign exchange market benchmark rates (“FX fixes”) (In re Foreign Ex. Benchmark Rates Antitrust Litig., 74 F. Supp. 3d 581 (S.D.N.Y. 2015)), and most recently reference rates for financial derivatives (“ISDAfix”) (Alaska Electrical Pension Fund, et al. v Bank of America Corporation et al.).The complaints filed in these cases all include claims under Section One of the Sherman Act alleging anticompetitive conspiracies among defendant financial institutions. The district courts, however, originally reached a different conclusion in the LIBOR litigation than in the FX and ISDAfix litigations regarding whether the type of alleged rate manipulation would give rise to antitrust liability.

LIBOR, which stands for the London Interbank Offered Rate, was designed to reflect the average rate that leading banks in London pay for short-term loans. LIBOR rates were set based on submissions by participating banks to the British Bankers Association. Several banks were accused of deliberately misreporting their LIBOR submissions and thereby tainting LIBOR rates. Allegedly false LIBOR submissions benefited defendant banks in several ways. Some were intended to improve trading positions held by bank trading desks. Artificially low submissions could lower payments on bank liabilities pegged to LIBOR and could present the banks to investors and regulators as financially healthier than they actually were.

The FX manipulation cases involve foreign exchange dealers allegedly colluding to move spot FX rates and affect the determination of key FX benchmarks (daily “fixes”).Currency dealers allegedly took advantage of their knowledge of pending client orders, which referenced certain future benchmark rates, and traded to their own benefit (“front-running” of client orders).

In an effort to move FX rates to their advantage, dealers also allegedly colluded to concentrate trades from multiple institutions just before benchmark rates were set with the intent of manipulating spot FX benchmarks (“banging the close”).

The ISDAfix is a benchmark rate referenced by many financial derivatives. Like LIBOR, the ISDAfix is computed based on data submitted by dealers regarding hypothetical transactions and not actual transaction data. ISDAfix submissions, however, are made in response to market-based actual rates offered in inter-dealer trades and executable inter-dealer bids at a particular time of the day. Dealers can accept the market rate, submit a different rate, or take no action. Plaintiffs’ allegations in this case are similar to those in the FX case, namely that defendant banks conspired to manipulate the US Dollar ISDAfix by coordinating trading to generate a desired reference rate at a particular time of day, i.e., banging the close. Banks then allegedly adopted the reference rate for purposes of making ISDAfix submissions rather than determining submissions based on their own bid/ask spreads.

In all three cases, plaintiffs brought antitrust claims related to defendants’ collaborative conduct. Courts, however, have not adopted a universal view of these antitrust claims. In the LIBOR case, the court found that plaintiffs’ alleged conspiracy did not undermine competition or cause antitrust injury. Thus, the court dismissed the antitrust claims in this case.

In the FX and the ISDAfix cases, in contrast, the courts refused to dismiss plaintiffs’ Sherman Act claims at the pleading stage. The root of such divergence can be traced back to the economic effects of the alleged conduct in each of the cases.

Construction of reference rates based on submissions of market participants is by definition a collaborative process. Without input from competing financial institutions, reference rates cannot be computed. The alleged collective actions of market participants, however, differ across cases and have different economic effects on competition. In the LIBOR litigation, the court viewed the collaboration of the participating banks as necessary for the existence of LIBOR rates. Thus that collaboration, by itself, was not deemed anticompetitive. The conduct at issue concerned a hypothetical market transaction and not an actual transaction, and banks’ alleged concerted actions were found not to have reduced actual competition. On appeal, however, the Second Circuit determined that any process by which competing firms set a price or a component of price (like LIBOR) represents horizontal price-fixing and is thus a per se violation of antitrust law. This finding led the appeals court to remand the case for additional consideration by the trial court of issues related to antitrust standing and injury.

As with the LIBOR rate-setting process, the determination of ISDAfix and FX benchmark rates requires the collaboration of market participants through a process that by necessity is not competitive in nature. The determination of ISDAfix is similar to the LIBOR process in that participating institutions are queried about rates for hypothetical transactions and not actual market transactions. The ISDAfix and FX benchmark rates, however, also incorporate as key inputs to the reference rate-setting process market-based rates that defendants allegedly altered through coordinated efforts. In particular, plaintiffs allege that by coordinating to bang the close and achieve a desired rate, defendant dealers pushed actual rates away from competitive rates. As a result, plaintiffs have claimed that the alleged conduct in these cases disrupted the workings of otherwise competitive markets and caused them to suffer economic harm.

The FX and ISDAfix cases explicitly allege coordinated conduct among defendant banks to engage in actual transactions that altered the outcomes of otherwise competitive markets. This alleged conduct has enabled antitrust claims to move forward in these cases. In contrast, the court’s ruling in the LIBOR case focused more on the rate-setting process itself, which the court deemed cooperative rather than competitive. The recent ruling by the court of appeals reopens the issue of cooperative rate-setting, with unknown consequences for antitrust claims.