The LIBOR affair has been described as the biggest banking scandal in history, a deception affecting not only banks but also corporations, pension funds and ordinary people. But was this just the tip of the iceberg? Was the scandal the work of a few bad apples or an inevitable result of a financial system rotten to its core? Labelled “one of the world's most infamous rogue traders” in the wake of a mis-marking scandal, Alexis Stenfors went on to rebuild his life and now guides us through the shadowy world of modern banking, providing an insider’s account of the secret practicesincluding the manipulation of foreign exchange ratesthat have allowed banks to profit from systematic deception. Containing remarkable and often shocking insights derived from Stenfor’s own experiences in the dealing room, as well as his spectacular fall from grace at Merrill Lynch, Barometer of Fear draws back the curtain on a realm that for too long has remained hidden from public view.
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About the Author
Alexis Stenfors spent fifteen years as a trader at HSBC, Citi, Crédit Agricole, and Merrill Lynch. He is currently a senior lecturer in economics and finance at Portsmouth Business School, UK.
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Barometer of Fear
An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History
By Alexis Stenfors
Zed Books LtdCopyright © 2017 Alexis Stenfors
All rights reserved.
THE BAROMETER OF FEAR
My first encounter with LIBOR came in August 1992. I had finished a semester at the University of Cologne as part of a university exchange programme, and was given the chance to extend my stay in Germany for five months by doing an internship.
I had just written an essay entitled 'Exchange-rate Risks and Hedging Strategies', and sent an application to the second-largest bank in Frankfurt: Dresdner Bank. They seemed to like that I was interested in derivatives and foreign exchange markets and invited me to an interview. A month later, I found myself in the back office for interest rate derivatives.
I rented a cheap room in the Bahnhofsviertel, just a few blocks from the central station and within walking distance from the bank. It struck me that the heroin addicts who inhabited the red light district and the park next to it did not seem to pay any attention to the swarms of bankers in dark suits who walked past them every morning. But the ignorance seemed mutual.
I was seated next to a gold trader who was approaching retirement and for some reason did not have a desk on the trading floor below. He was probably 40 years older than me and constantly made jokes in an amusing Düsseldorf dialect. I liked him. Somehow, he had access to the vault in the basement, which held the bank's stock of gold bars. Once (he was probably eager to impress), he took me downstairs. It was huge and looked exactly as I'd imagined it would from watching films. He invited me to hold one of the bars. I can still remember how astonished I was by its weight.
I was fascinated by the buzz on the twenty-seventh floor, where the trading took place. I had never seen anything like it. Grown men (there were not many women around) in suits shouting down phone lines, shouting at each other, or doing both at the same time. But I was also intrigued by the large numbers on the time-stamped trade tickets that were passed to the back office throughout the day. They could be 10, 50 or 100 million deutschmarks (or dollars, pounds, francs ...). And they all related to the newly invented derivative instruments: interest rate swaps, forward rate agreements, cross-currency basis swaps, caps, floors and so on.
The actual work I did, however, was not that exciting. When a deal was done on the twenty-seventh floor, the trader would scribble some details on a ticket the size of an A5 sheet of paper. Each ticket was numbered and had boxes that had to be filled in: Instrument, Counterparty, Buy/Sell, Benchmark, Maturity, Currency, Amount, Trade Date, Fixing Date, Settlement Date, Deal Rate.
We regularly took the elevator down one floor to pick up the tickets. I then had to check whether the trade details corresponded to the deal confirmations sent out to the counterparties, and whether the confirmations sent by the counterparties corresponded to the confirmations sent by the bank. They had to match. What mattered to us in the back office was that clients and banks received their trade confirmations promptly, and that the correct payments were made and received. Some clients were more important than others, we were told, and their deals needed to be processed faster. Some traders also appeared to be more important than others, and their trades had to be prioritised.
Everything else was just about numbers, and after having seen thousands of such trade tickets, the fascination with the big numbers gradually wore off. It was just a job, and equally monotonous as sorting and packaging tomatoes, which I had done throughout the whole summer in 1989. It was like a factory. A box filled with 10 kilograms of vegetables had been replaced by a box filled with 10 million deutschmarks' worth of financial derivatives written on a feather-light piece of paper.
Of all the things that were checked on the trade tickets, the 'Benchmark' was probably the one that received the least attention. The box simply contained a fiveletter word in capital letters: LIBOR, FIBOR (Frankfurt Interbank Offered Rate), sometimes PIBOR (Paris Interbank Offered Rate).
The five-letter words referred to which interest rate would be referenced when the contract was settled at some point in the future. The rate would then ultimately determine whether the bank (or the client) had made or lost money – and how much – by having done the deal in the first place.
The interest rate was simply a number provided by Telerate, a market data and information provider that competed with Reuters. Every day, around lunchtime, page 3750 on Telerate would be updated with the new LIBOR interest rates for different currencies (US dollars, British pounds, Swiss francs, etc.) and for maturities ranging from one day to one year. Page 22000 would contain the FIBOR rates, page 20041 was dedicated to PIBOR, and so on.
The numbers looked a bit like The Matrix: a grid of orderly sequences of flickering green numbers filling up a black screen.
* * *
I have often said to people that I became a trader almost by accident, but that is only partially true. The fact is that I had been interested in foreign currencies, foreign languages and international affairs since I was a child. I quite liked maths, and went on to study at the Stockholm School of Economics. In that sense, trading was undoubtedly a job where I would be able to make use of my skills, while also having the opportunity to analyse international trends and events on a daily basis.
However, when I returned to Sweden to finish my master's degree in December 1992, there were not many jobs around in finance (or at all, to be honest). Sweden was recovering from a devastating banking crisis and the situation in Finland, my home country, was even worse. The Soviet Union, Finland's biggest trading partner, had collapsed and a long era of austerity had arrived. Everyone, it seemed, had a hiring freeze, not least the banks, which were either bankrupt, had been nationalised, or were afraid of going bankrupt or being nationalised.
The only ad that I found on the noticeboard outside the Student Union matching my educational background was from Midland Montagu. It was a British bank with a tiny office in Stockholm, and they were looking for money market trainees. I applied, stating in my letter dated 17 June 1993 (freely translated): 'Starting as a money market trainee would not only be a great challenge, but also provide me with great pleasure and stimulation. Even though I lack rigorous work experience, I am somewhat familiar with, and particularly have a burning interest in, money markets and economics.'
From then on, things moved quickly. I got an interview, and they offered me a job – not as a trader but as a sales person. At the time, I didn't really know the difference between the two, but I happily accepted anyway. The client base consisted of insurance companies, pension funds and large Swedish multinationals making cars, refrigerators, phones or flat-pack furniture. I would be given a list of (the least lucrative) clients and I had to try to convince them to buy or sell T-bills (treasury bills), government bonds and mortgage bonds.
The basic idea behind these products was rather simple. Imagine you decide to lend £1,000 to a friend for a year, and that your friend promises to pay back the whole amount plus £100 in interest. You have now entered into a standard loan contract where you run the risk that your friend might not be able to pay the money back. A Tbill, however, would work as follows. Your friend announces that they want to borrow £1,000 and would be prepared to pay it back with £100 in interest. They issue a piece of paper stating that £1,100 will be paid to whoever happens to own that paper in a year's time. From your perspective, this is a slightly better proposition. Should you, in a couple of months' time, begin to doubt your friend's ability to pay the whole amount, you could try to sell the paper to someone else (perhaps even an enemy). Your friend might like the T-bill idea too, because, in theory, money could be borrowed from almost anyone. In reality, however, only large institutions are able to raise money this way.
T-bills are securities that expire within a year and are issued by governments, whereas bonds refer to papers with longer maturities. Mortgage bonds are securities issued by institutions involved in mortgage lending. Considering the small size of the country, the Swedish fixed-income market (the common name for these products) was enormous. The government had borrowed a lot for an extended period of time and therefore had accumulated substantial debts. These debts could be traded in the market as securities, and this is precisely what we did.
The dealing room was minuscule compared with the one I had seen in Frankfurt, containing no more than 15 or 20 seats. In fact, it looked more like a gentlemen's club than a bank: high ceilings, expensive oak floors, chandeliers and only a discreet sign outside revealing the nature of the business conducted by Midland Montagu on Birger Jarlsgatan in Stockholm.
My training programme, which took place on day 2 and day 3 of my employment, looked like this:
10.30 Credit and Risk
13.00 Finance Department
14.00 Back Office
15.00 Equity Department
09.30 Human Resources
10.30 Corporate Banking
On day 4 (having successfully completed my training course in less than 48 hours), the time was ripe to learn how to become a trader. It turned out that just a few weeks before I joined, Swedbank (a large Swedish bank) had poached every trader but one from Midland Montagu. The situation was a bit uncertain to say the least, and the junior trader who had decided to stay was catapulted into the position of acting chief dealer. The sales person with whom I was supposed to work suddenly became assistant trader. This was neither the time nor the place for me to be trained as a sales person looking after clients. The pecking order was made clear to me. A sales person could be sacrificed for a trader, but never the other way round.
The chief economist took charge of the training. An odd choice perhaps, but he was very respected in the dealing room and also happened to know the ins and outs of trading. It was old school. The junior economist, who was the other new recruit alongside myself, and I were told to stay in the dealing room for an hour after work one evening. The session was about learning how to master the technique of using two ears, two hands and two telephones to call two banks at the same time.
The chief dealer might have to buy 500 million T-bills from the other market makers to cover a client trade. As the dozen or so banks and brokerage firms quoting Swedish T-bills did so only in tickets of 50 million, we would need to deal with ten of them. The task therefore required five people. The chief dealer would tell the five traders to call out on, say, the 'December T-bill' (a debt obligation issued by the Swedish government maturing in December). We would then each press the speed dial to the two banks that were designated to us and ask for a two-way price on the December T-bill. One by one, the banks would quote a price at which they would buy (a 'bid') and at which they would sell (an 'offer') 50 million. One by one, these prices would be shouted across the dealing room to the chief dealer, who would then decide what to do and would shout back 'Mine!', 'Yours!' or 'Thanks, but nothing there!' We would then immediately repeat 'Mine!', 'Yours!' or 'Thanks, but nothing there!' to the person on the other line.
Clients were referred to as market or price 'takers', referring to how they approached the market place. We and our competitors, on the other hand, were market or price 'makers', as we quoted the prices they could trade at. One of the key requirements to becoming a member of the market-making club was that you always had to quote two-way prices to the other club members: a bid and an offer at the same time. A gentlemen's agreement also dictated that you had only a few seconds to decide what to do. Otherwise, the person on the other line would shout 'Risk!' This meant that you could no longer deal based on the stated price and would need to ask again. If, however, you had dealt on a price, you had the right to ask the same bank for another price before they hung up. In this case, the unwritten rule stated that you should ask: 'Next price, please?'
It reminded me of the games we used to play after school when I was a child, where a series of strict rules were solemnly announced ahead of play by the older and more experienced children. As a beginner you would never ask why and how these rules had been invented, or by whom. And when a new player arrived, you recited the rule book as if it were the most natural thing in the world. You did not break the unwritten rules, nor did you ask why they existed.
A 'call-out' was very quick, exciting, loud and sometimes quite chaotic. A large client trade or a choppy market resulted in a large number of trade tickets with different banks in different amounts and at different prices. This invariably meant even more market movement. As soon as we hung up the phone to the other banks, they were already calling us on the other lines because their traders had been commanded to press their speed dials to demand prices from us.
An attack led to retaliation, and sometimes it felt like we were foot soldiers repeatedly sent out on missions to shoot at each other. I don't remember if I ever got to meet the two traders who were responsible for picking up the phone at Aragon and Aros, the two brokerage firms behind the enemy line designated to me. However, after thousands of phone calls, hostility was gradually complemented by sympathy and mutual respect. Our loyalty was shared between the bank we worked for, the market we traded in, and the rules of the game. And just as your closest colleague was not always your best friend, your fiercest competitor was not always your worst enemy.
Sometimes call-outs were made for no particular reason, or simply to check the barometer. A string of low prices would indicate that banks were keener to sell than to buy. High prices hinted the opposite. Call-outs were also made to hear the voice of a competing trader. Did he or she sound relaxed, stressed or perhaps nervous about something? Or to listen to the noise levels in the other dealing rooms across the city. What were they up to?
As a result, clients had to be given nicknames in case an incoming caller might accidentally snap up some confidential information. A large construction company might be renamed 'The Screw' or a car manufacturer 'The Shark' (perhaps referring to the copious amounts of hair gel the customer used). These codenames were then changed regularly in order to protect trade secrets and clients' identities. Traders, too, were given nicknames. Paradoxically, such nicknames later came to be used in order to reveal, rather than protect, identities that were supposed to remain secret.
A trader's 'book' would consist of all the trades a trader had in his or her portfolio. A trader's 'position' was then a general term for how sensitive this book was to different price movements in the market. This sensitivity would normally be expressed in the amount made or lost if the market moved by one basis point (0.01 per cent). A 'long position' meant that money would be made if prices in the market went up, and a 'short position' was the opposite. The chief dealer had an assistant keeping track of the positions. It was, of course, necessary to know whether you had accidentally bought too little or too much. You did not want to find out that 50 million T-bills were missing when the market closed for the day. Who knew how much they would cost tomorrow?
When the market was volatile, mistakes happened rather frequently. Simply the fear of a possible mistake could lead to irritation and heated conversations. As all phone conversations were recorded, junior traders were often sent out to listen to the tapes of each individual call. It goes without saying that, with the phones bugged, you tried to keep your private life relatively private when you were in the dealing room. Beyond this, nosiness and gossip outside the dealing room were generally frowned upon. Perhaps the collective feeling of constantly being observed led traders to accept and tolerate each other's vulnerabilities. Although the dealing room banter could be raw and unfiltered, it was supposed to be kept secret from 'others'. This naturally strengthened the feeling of 'us versus them', 'them' being pretty much everyone who wasn't a trader (or maybe a sales person or broker).
* * * My life as a trader was shaped to some extent by the transformation of the banks I worked for. Midland Montagu became Midland Bank Stockholm Branch and we moved to a new dealing room. Soon afterwards, new business cards had to be printed as we adopted the HSBC brand. Within two years, we had developed from a boutique merchant bank into an integral part of an ambitious global banking giant. We, as the tentacle in the Nordic region, would now serve clients not only by quoting prices in bills and bonds, but also in FX and interest rate derivative instruments. Tomas was brought in from Hong Kong to run the dealing room, and extra expertise was flown in from London. A small army of traders and sales people was hired, mostly from Nordbanken, which had been nationalised following the Swedish banking crisis.
Excerpted from Barometer of Fear by Alexis Stenfors. Copyright © 2017 Alexis Stenfors. Excerpted by permission of Zed Books Ltd.
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Table of Contents
Introduction: 'It's a misunderstanding' 1
1 The barometer of fear 17
2 'Why did you do it?' 56
3 Superheroes and beauty pageants 70
4 The LIBOR illusion 107
5 The value of secrets 154
6 Conventions and conspiracies 187
7 Rotten apples 235
8 The perfect storm 275