This raising of the global legal stakes comes at an awkward time for European competitors such as Barclays and Deutsche Bank, which are already struggling mightily to deal with the other ‘L’ word: approaching leverage ratio requirements. JPMorgan has not yet started openly pushing the theme that its ability to pay enormous legal bills without blowing a hole in its balance sheet is a competitive advantage. Even the most dewy-eyed Jamie Dimon admirers among the bank’s shareholders might complain if the CEO started bragging about shelling out tens of billions of dollars in legal settlements.
But JPMorgan is already getting plaudits from some analysts for moving quickly to settle its legal woes, and many of its competitors are in a much worse position to deal with the escalating costs of former abuses.
The broadening of the Libor scandal to a wide-ranging investigation of potential manipulation of foreign exchange benchmarking by banks is set to add to the industry’s legal bill and might hurt future fixed-income revenues as more business lines fall under a cloud.
Analysts at KBW made an estimate in mid-November of potential civil litigation costs for investment banks – on top of approaching regulatory sanctions – of almost $100 billion.
The total was split between $24 billion of expected costs over mortgage securities, $26 billion of foreign exchange abuse claims, and $46 billion of Libor/Euribor litigation settlements.
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There are some broad assumptions in the KBW methodology, but its use of settlements already agreed in claims against banks by the Federal Housing Finance Agency (FHFA) in the US over mortgage securities sold to Fannie Mae and Freddie Mac at least provides an initial basis of observable deals. The FHFA is obtaining totals in excess of 10% of the face value of the debt sold, with JPMorgan’s $4 billion payment coming at 12% of disputed securities.
These totals were used to derive KBW’s estimate of $24 billion of industry-wide payments to settle FHFA claims, and a similar approach was taken to reach the estimates of $26 billion of FX claims and $46 billion of Libor/Euribor civil litigation costs.
KBW used Euromoney’s 2013 overall market share data to arrive at an estimate of potential FX civil litigation costs for the main dealers, working on the basis that claims could cover as much as 70% of trading.
The analysts assumed $5.3 trillion of daily traded volume, multiplied by 200 trading days a year, and that monthly FX fixes were manipulated half of the time over a four-year period by 20 basis points. It then layered on another assumption that civil plaintiffs would settle for 10% of relevant deals to come up with a potential settlement of almost $26 billion across the industry. That total could account for some fairly hefty payments by individual banks – KBW’s methodology would involve a $3.9 billion litigation bill for Deutsche Bank, followed by $3.8 billion for Citi and $2.6 billion for each of Barclays and UBS.
KBW took a similar approach to reach its estimate of $46 billion of civil litigation costs for Libor/Euribor manipulation, by assuming that 71% of interest rate derivatives are with customers (including non-dealer banks) and that fixings were manipulated for four years, with Libor suppressed 25% of the time by an amount of 20bp.
Barclays came top of this league table of estimated litigation costs, at $4.2 billion, followed by JPMorgan and RBS at $4 billion, Bank of America at $3.5 billion and Deutsche Bank at $3.4 billion.
There are many details in KBW’s approach to potential foreign exchange and rate-fixing litigation costs that can be debated, especially when it comes to the amounts it estimated for each bank.
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KBW used the overall FX market share data produced by Euromoney as its starting point, for example. The rankings for dealer share of FX trades with asset managers – the biggest users of the daily fixes that might have been manipulated – are different, however. Citi was the number-one dealer for spot and forward FX trades with real-money accounts in this year’s survey, followed by UBS, then JPMorgan and Deutsche Bank. State Street, which does not feature in the overall market share top 10, but previously had issues with its treatment of custodial FX clients, also has a place at the overall real-money top table, at number eight in the 2013 survey.
Some of the assumptions about interest rate trading market share made by KBW are also debatable, but the broad thrust of its findings about likely civil litigation costs for the industry are certainly plausible.
And further regulatory fines will come on top of civil litigation. The regulatory sanctions agreed so far for Libor abuses have shown a strong correlation between the number of employees involved and the size of fines, which offers at least a ray of hope for some banks, such as Deutsche Bank and JPMorgan, that must have been concerned that they would be fined primarily on the basis of their revenue or market share in rates trading. The fines that had been levied by mid-November for Libor abuses were averaging $32 million for each employee involved, which is substantial, but would likely be viewed as manageable by investment bank heads who are inured to big write-offs, especially when they are experienced across the industry.
European supervisors have made repeated mention of potential fines based on turnover for financial market abuses, however, so big dealers that had only a few staff involved in malpractice might not be off the hook.
And the metastasizing nature of the scandals over setting of benchmarks threatens to deal a permanent setback to bank revenues from fixed-income, currency and commodities trading.
When the details of Libor manipulation started coming to light, senior managers at investment banks could plausibly claim that it was the work of a few bad actors concentrated among relatively junior staff. This approach left plenty of unanswered questions, but it at least gave senior bankers a narrative to offer clients and a path to partial redemption: fire some staff, suck up the fines and try to move on.
The swelling tide of allegations about abuses across fixed-income markets – commodity benchmarks are now also under investigation and could join rates and FX fixings in fines and sanctions soon – undermines this approach of plausible deniability by senior bankers.
This in turn increases the chance that the fixed-income markets that emerge from an eventual cleaning of the Augean stables will be much more electronic and much more like equities than had seemed likely even a few months ago. And that could spell a long-term erosion of earnings power for some of the fixed-income flow monsters that thought they had created a self-sustaining oligarchy. Even if banking heads at those firms can avoid the fate of Bob Diamond and Jerry del Missier of Barclays, who lost their jobs when Libor abuses started to come to light, they might find a fixed-income revenue recovery painfully elusive.
