Monday 6 September 2021

Truth and Liebor

 This will be a bit different from my normal posts. It's basically some personal reflections on the LIBOR fixing scandal, prompted by having just read this book written by Stelios Contogoulas

This post isn't really a book review, although I will say that the book is definitely worth buying. Most of you have probably already read the excellent Spider Network. That is arguably better written than Stelios' book (as it's written by a professional journalist, and as anyone who has read my books knows ex-traders are not always naturally gifted writers - Nassim Taleb is a black swan in this respect). Stelios' book is less polished, but he still does a good job of hooking you into the narrative and it got very exciting towards the end.

More importantly, as far as I am aware Stelios is the only person who has written a book about this scandal from the inside. And his book is very thoughtful and reflective, and his reflection has inspired some personal thoughts of my own.

Three traders

This post is about three people. One of them is Stelios. Another is an Italian by the name of Carlo Palombo. And the third is me.




What do we have in common? Well, we're all in our forties, and our hair has long since departed our scalps. But more importantly we were all trading interest rate derivatives at Barclays Capital (as the investment banking arm of Barclays bank was known at the time) at the same time: from around September 2002 to February 2004 (when I left the bank). 

In fact until early 2004 the life and career of myself and Stelios followed an eerily similar track. Stelios of course grew up in Greece not England and is three years older than I am, but like me he lived abroad as an expat child. Like me he was interested in computers, and like me he decided a career in IT was not for him (in my case I dropped out after my first year at University, in his case after several years in IT consulting).

We both returned to education a little later in life, attending the University of Manchester at the same time. I was a mature Economics undergraduate, whilst Stelios was doing an MBA. We overlapped by about 18 months but we probably never met, although many of our lectures would have been in the same building.

Stelios was hired by Barclays in early 2002 as an associate after doing an internship (at the same time as I was doing an internship at AHL). When I was being interviewed for a position on the Barclays analyst programme, he had probably just started in the Canary Wharf office (5 North Colonnade - the home of Barclays investment bank then, and now, at least until next year). We were interviewed by some of the same people, a few months apart. 

We were both hired, I suspect, for ulterior motives. Stelios' computing experience meant that he didn't start properly trading for a couple of years, as he was initially tasked with rebuilding the banks yield curve systems. My instinct is that I was hired because I had the right personality and was a few years older than the other graduates - more of that in a second.

In September 2002 I started on the graduate programme. The programme covered around 75 analysts and associates, covering back, middle and front office. I was one of only two traders. The other was Carlo Palombo. 

Derivatives trading at Barclays

Stelios and Carlo were working within a few metres of each other, both working on the interest rate swaps desk (which also traded FRAs). I was on the next bank of desks, but no more than 10 metres from each of them. My job was a little fancier; at least in theory. I was working on the exotics rates desk, which confusingly covered both vanilla options (swaptions, caps and floors) as well as actual exotics (bermudans, CMS, PRDMC...). However like Stelios and Carlo I was very much a junior trader.

My line manager was the desk MD, a very smart and decent guy who looked like a bouncer. But I reported day to day to the desk's senior trader, who ran the main vega book (options maturing in over a year; there was also a gamma book for shorter options which I eventually took over, plus various traders trading FX, caps/floors, inflation; and we also had an on desk quant / trader for the very fancy stuff). 

A thinly disguised version of this bloke appears in my first book ('Sergei'). He was an extremely unpleasant person to work for. I suspect I was hired - despite not having the Phd everyone else on the desk had - because it was thought with a few years of work experience I would be able to deal with this character better than a 21 year old neophyte or fresh faced Phd. It sort of worked - at least for me; I didn't end up being a glorified coffee boy like most junior traders as I refused to take any crap.

But Carlo was reporting to a guy called Jay (who traded the short Euro swaps and FRAs), who made my senior trader look like an social worker.  He really gave Carlo hell, and the poor guy practically cowered under the tirade of abuse he got if he made even the slightest error. I felt sorry for Carlo, as I was working relatively relaxed hours (7am to 5pm), much less than the other analysts on the IB programme, and also a lot less than Carlo who practically had to sleep under his desk to keep up with the workload. Interestingly in Stelios' book he refers to Jay as:

 '... very demanding as a person- particularly with juniors - but when he liked someone, he was a great manager and mentor'. 

OK. Maybe I just didn't see his good side - perhaps he didn't like me or need to like me, or maybe I'm just a snowflake who was too soft to work on the trading floor. I certainly couldn't have worked on the swaps desk which was much larger than ours, and always seemed to have at least five people yelling abuse at each other. 

Outside of business I knew Carlo reasonably well as there were often nights at the pub or house parties with the other members of the grad programme, but I probably only spoke to Stelios half a dozen times during my time at Barclays. 

The crucial post it note

We didn't have a huge amount of interaction with 'the delta desk' as we disparagingly called the swaps traders, although we were supposed to do our hedging with them internally, and we also used to occasionally get them to clear up the fixing risk on our books. Sometimes a complex deal would need co-ordination between the desks, but mostly we had a friendly(ish) distant rivalry. We thought the delta traders were a bit simple (how hard could it be to trade swaps and FRAs, compared to bermudan swaptions?), and they probably thought we were a bit lazy and arrogant. As a junior trader from the stuck up exotics desk I tried to avoid the very scary looking senior swaps traders like Jay wherever possible.

One day however we had some large expiries in our book, and the market price was very close to the strike. 

About 15 minutes before the expiry (and fixing time) 'Sergei' leant over to me and in an uncharacteristically quiet voice said 

"Go tell X that we have a large expiry on this morning". 'X' was a senior swaps trader

'Oh come on, don't make me walk over there. Why don't I just message or call him' I moaned, not fancying running the gauntlet of the swaps desk.

'Don't be so f***** stupid. Go over and tell him, face to face.' hissed Sergei in reply. I rolled my eyes.

'For f**** sake' he muttered, and grabbed a post it note 'Just do it. Here is the expiry we have on. I've written it down so you don't forget it. Make sure you get it right. And make sure you bring that post-it note right back here'

Now I was intruiged. This was more like a spy mission than the normal humdrum business of trading. I wandered over to X (who fortunately was one of the nicer blokes on the swaps desk), and passed the crucial information on.

'We have this expiry today' I said, and read off the post it note. X nodded sagely but said nothing. I stood there for a few moments, not sure exactly what was supposed to happen next. He turned back to his screen, which was obviously my cue to leave. 

I returned to my desk, and sat down. Sergei held out his hand without looking at me.

'Post it note' he snapped. I pulled the scrap of yellow paper out of the pocket I had stuffed it into, and passed it over. I watched as he methodically tore it into tiny pieces, and then put the pieces into his own pocket. Then he turned to me and winked. Belatedly, I realised what had just happened.

Some background information, swaptions (options on swaps) were mostly cash settled against something which you can think of as a bit like a 'Swap Libor' fixing. Like LIBOR it was calculated daily from an average of figures given by a panel of banks. The swaps desk was resposible for submitting their estimated figures of where swaps were trading at a specific time each morning.

Note here the direct analogy with LIBOR:

The swaptions desk will gain / lose if swaps fix in a particular place
-   The swaps desk will gain / lose if LIBOR fixes in a particular place
The swaptions desk are not responsible for submitting the swap fix - the swaps desk are
-   The swaps desk are not responsible for submitting the LIBOR fix - the cash desk are
To influence the swap fix the swaptions desk will have to speak to the swaps desk
-    To influence the LIBOR fix the swap desk will have to speak to the cash desk

Now, I am not saying that Sergei was trying to influence the swaps fix that day in favour of our expiry. And indeed, the message I had passed on was not 'We'd like the fix to be higher today please' All I had told X was the position that we had on. Of course, X could have easily inferred where we would like the fix to be. And he could have used that to change the rate he submitted. 

All in all, it seemed a bit fishy. If this was kosher, why the secrecy? Why didn't Sergei want any electronic or taped record of my conversation with X to exist? Why had he torn up the post it note, and even been careful enough not to put it in the bin by his desk, but presumably take it home for more secure disposal? 

To be clear: I didn't even have the slightest thought that it might be illegal; nothing like this had been covered in eithier my regulatory exams or in the training the bank had provided. And I'd had no formal training whatsoever on the swap fix, or even the expiry process. Still it was definitely a step beyond my own moral boundaries I turned to Sergei and said as confidently as I could:

'I'd rather not do that again if it's okay with you'

He looked at me and smirked. 'Whatever. Now see if you can find a broker to buy us some lunch. I fancy some Ubon today.'

I felt like I'd failed some kind of test, but whatever he thought I was never asked again. In case you're wondering, I don't remember there being anything 'weird' about the expiry today, nor do I remember if we ended up in a profitable position. I have no idea whatsoever if X did anything at all, or if he was just being polite and pretending to do us a favour. 

And, for what it's worth, I never saw any evidence that any further requests were made by Sergei or anyone else. Perhaps he was just very discreet, perhaps it was a very rare event which I just happened to be part of, or perhaps I'd shocked him into a more virtous life (although that seems unlikely). 

What I did next

Over the next few months there were other things that seemed fishy to me, but I couldn't avoid doing most of them. One of them I have talked about for several years now, here, in the newspapers, to the UK parliament, and on TV: the practice of selling embedded derivatives to local authorities and housing associations as part of 'LOBO' loans.

Importantly, there was nothing secretive about the LOBO business: communication was done properly over recorded lines, and there were no post it notes bandied around. I remember only one exception, which I described in my earlier blog post:

"On this particular deal the commission was so large in percentage terms that it exceeded internal limits. Even the most hard nosed traders on the trading desk were feeling pangs of.... well not guilt perhaps but fear that this kind of thing might one day be written on a blog. But the broker agreed to take half of the commission spread over subsequent deals, so that was okay."

For that trade there was indeed a lot of whispering, and the real commission was never written down or discussed in a recorded setting - not even on a post it note (it might have been written in biro on someones hand). 

Again it was clear to me that was going on was definitely immoral, but I never even considered it might be illegal. And of course, no court has ever found that Barclays (or any other bank) were engaged in illegal activity in relation to the LOBO deals and there has been no regulatory action. But the banks have 'voluntarily' agreed to 'tear up' many of the LOBO deals and replace with straightforward loans, often taking significant mark to market losses in the process. 

(I remember going to a compulsory course on ethics at Barclays where they told us not to do anything that could end up on the front page of the newspaper, even if it was legal. That amused me no end when I was quoted on the front page of the FT in reference to the LOBO scandal).

The morally grey activities and the stress of working on the sell side all got a bit much for me.  I decided in Febuary 2004 to leave Barclays. My MD tried to make me stay; he even broke the rules and told me what my year end bonus would me if I stayed at least until April. I pointed out that I was probably giving up a lot more money in the long run, but this wasn't for me, and I wasn't entirely happy with a lot of the stuff we were doing.

You know the rest if you've followed my blog; I did a couple of years at an economics think tank and then joined AHL in 2006 where I lived happily every after (at least until 2013, when I left and now live happily ever after writing stuff for you guys to read). 

What Stelios and Carlo did next

What happened to Stelios and Carlo? Well they both stayed at Barclays, and not long after I left Stelios was allowed to begin trading properly, initially on the sterling FRA book, then subsequently covering USD short end swaps for the London desk. And at some point, both were asked to pass on requests to cash desks to ensure LIBOR and/or EURIBOR fixes reflected their trading book.

It's worth quoting from Stelios' book:

"One morning, Fred stood up from his chair...  'Come with me, there's someone I want you to meet'

The two of us walked a few rows away on the edge of the trading floor... Sitting there was Peter Johnson... He was an Englishman in his early fifties with already a long career at Barclays. He was an established, succesful, and very senior trader.

'Stelios this is Peter....' said Fred 'He is the US cash trader here at Barclays and he's the person responsibile for submitting LIBOR rates for the bank. Alex and I will be asking you on occasion to relay some information to him, relating to LIBOR rates and our preference on it. So, all you have to do is to let him know, OK?'

Peter got up... 'Nice to meet you, Stelios. Just let me know whenever you boys need something and I'll do my best to help out' he said."

And thus the die was cast.

The LIBOR scandal

When the rumours about LIBOR first surfaced in 2008 (and ironically, I think it was Tim Bond from Barclays who brought 'lowballing' to everyones attention), I immediately remember the incident from five years earlier. My first thought was 'Yes, that's absolutely what would have been happening', and then 'Wait, is that really illegal?'. 

The rest is history not worth repeating here; but for Stelios and Carlo it did not end well, as both were prosecuted for LIBOR and EURIBOR fixing respectively.  I won't tell you what happened to Stelios, you can google it if you like or better still read his book. Sadly, Carlo was sentenced to four years in prison, and could be there until 2023 (although hopefully he will qualify for an earlier release).

Several other traders were also found guilty, of which the most high profile was certainly Tom Hayes who was finally released a few months ago.

Why them, and not me?

I'm not going to discuss the rights and wrongs of the scandal here, I'm not going to debate as to whether any law was actually broken; nor will I tell you how I feel that only relatively junior people got prosectuted whilst their bosses got away with murder. You can read Stelios' book, as he's basically in broad agreement with me on all of these issues.

But there is one point I want to finish with. In Stelios' book he includes this line:

"Try to put yourself in my shoes and think about how you would have acted in my place"

For me this is especially poignant. It really could have been me. I wasn't actually in Stelios' shoes, but I was standing (or rather sitting) just a few metres away. And yet I acted quite differently.

I'd like to think that it's because I have an especially finely tuned moral compass, but if I'm being brutally honest I'm not sure that's the case (and to be fair to Stelios, in my limited personal dealings with him, and in his book, he comes across as a pretty decent guy).

Realistically, if I was in Stelios' shoes, or Carlo's for that matter, I probably would have done what he / they did. After all, we had a lot in common, quite apart from our near parallel career tracks. We had no training whatsoever on the legal or regulatory ramifications of rate fixing. Furthermore, we were working as juniors for domineering bosses who brooked no disagreement, although Stelios and I probably coped better than Carlo.

There are two main reasons why I didn't make the same decisions. Firstly, we were doing jobs that were quite different. Rate fixing had a much bigger impact on the swaps book than on ours (to use some jargon, we were running much smaller delta positions), so seeking to influence fixing rates just doesn't seem to have been such a big part of the job.

And secondly, if you reread the accounts of my brush with rate fixing and Stelios' description, they are quite different. There is none of the furtive nature of Sergei's instructions when you read what Stelios writes. There is no reason for Stelios to suspect that anything fishy is going on. It's just presented as completely normalised behaviour.

I am still not completely sure why Sergei was so secretive, given the practice of adjusting fixes was so commonplace. Perhaps he had some prescience about whaat was going go happen in the future, perhaps it was for his own amusement as part of the 'test', or perhaps it was just his Russian upbringing. 

"Try to put yourself in my shoes and think about how you would have acted in my place"

No comments:

Post a Comment

Comments are moderated. So there will be a delay before they are published. Don't bother with spam, it wastes your time and mine.