The complex world of inter-dealer broking took centre stage on Wednesday as UBS admitted that its traders paid bribes to brokers in return for their help rigging interest rates.
Britain's financial watchdog said unnamed brokers accepted "corrupt" payments - running at 15,000 pounds ($24,400) per quarter - from UBS for their help in manipulating the Libor benchmark rate.
They also engaged in pointless "wash" trades - where a bank does two trades that effectively cancel each other out - to earn more than 170,000 pounds in commission, the Financial Services Authority (FSA) said in a statement.
"During the relevant period, the UBS traders (one of whom was a manager) were directly involved in making more than 1,000 documented requests to 11 brokers at six broker firms," it said after UBS was hit with a $1.5 billion fine by British, Swiss and U.S. regulators for what the FSA called "pervasive" manipulation of global benchmark interest rates by dozens of UBS employees.
Questions have been raised about the role of broker-dealers in banks' rigging of Libor, used to price $350 trillion of contracts, since the scandal first broke. As the middlemen matching buyers and sellers of all sorts of financial securities, they speak to traders at banks daily, giving them a unique and privileged view of banks' trading activity.
When Britain's Serious Fraud Office (SFO) detained three men in connection with Libor rigging last week, the first arrests in the probe, two worked for an inter-dealer broker.
Broker-dealers spend their days reeling off prices down a phone, or through an electronic messenger, to traders at banks and other clients. Diligent ones speak to their clients every morning - giving them insight into banks' trading activity that could have been used to co-ordinate rate rigging.
One of those arrested was ex-UBS trader Thomas Hayes, according to a source familiar with the situation, while the others, Terry Farr and James Gilmour, both worked at London inter-dealer broker RP Martin, according to a separate source, who also spoke on condition of anonymity.
Meanwhile, the Canadian Competition Bureau has said a trader at a "cooperating party" - named by sources as UBS - worked with a broker at ICAP, one of the biggest broker-dealers, as well as with traders at five banks in the UK capital.
ICAP has suspended one employee and put three others on administrative leave in connection with the Libor probe, according to two sources close to the firm.
ICAP has said in the past that it is not involved in setting Libor but did not comment further on Wednesday.
RP Martin declined to comment on the details released by the FSA but said it was fully cooperating with the authorities' investigations.
UBS, through four of its traders, colluded with inter-dealer brokers to attempt to influence the Japanese Yen Libor submissions of other banks, the FSA said.
The regulator cited a request made by an unnamed UBS trader on Sept. 18, 2008, in which the trader offers to pay "$50,000, $100,000, whatever you want" to a broker if they keep the six-month Japanese Libor rate unchanged.
The FSA said UBS made corrupt payments to brokers over 18 months and initiated wash trades to reward brokers further.
Those payments could add upwards of 20 percent to the annual pay packet of a broker earning a typical 300,000 pounds ($487,400) a year including bonuses.
Showing "total disregard for proper standards", the brokers and UBS traders referred to each other as "SUPERMAN", "the three muscateers" and "captain caos", the FSA said.
INTERBANK LENDING MARKET
When banks want to borrow money, they phone a loan broker, such as ICAP or Tullett Prebon, who are among the biggest. Much of interbank lending - the market where Libor rates are established - takes place in the morning in London.
The rates at which banks borrow from and lend to each other are known only to the lenders and borrowers, and possibly to their brokers.
Every morning at around 1100 GMT, "panels" of banks send data to Thomson Reuters, parent company of Reuters, on how much it would cost them to borrow a reasonable amount in a specific currency for periods ranging from overnight to a year.
The reported borrowing rates are then used to calculate so-called Libor "fixings", which are compiled by Thomson Reuters on behalf of the British Bankers' Association (BBA).
In the hours before submitting their rates, traders at the panel banks can phone brokers to get estimates of where the brokers perceive the loan market to be.
Unlike the bulk of trade in financial assets which has shifted to electronic platforms, some of the business done by inter-dealer brokers, such as RP Martin and ICAP, as well as rivals GFI and Tradition, is still conducted by so-called 'voice brokers', via a phone.
"There will likely be an investigation into the brokers' role, but they, unlike the banks, don't have the financial muscle to accept any serious fine, so this could be a catalyst for consolidation among the brokers, who are already struggling because of lower trading levels," said Joe Rundle, head of trading at ETX Capital.
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