Inter-dealer brokers’ inside information

By Felix Salmon
September 25, 2013

It’s hard to keep track of all the charges coming out today, in a coordinated fashion, against inter-dealer broker ICAP. For those of you who like primary documents but who don’t fancy wading through 26 pages of the the English FCA complaint or 58 pages of the US CFTC order, let me recommend the juiciest one of the lot: the Justice Department’s criminal complaint against three ICAP defendants, Darrell Read, Daniel Wilkinson, and Colin Goodman.

Goodman is the cash broker, based in London, who called himself Lord Libor. Every day, he would send an email to the various banks which contributed to the daily Libor fixing, giving them “suggested Libors” for where they should report yen Libor at 1-month, 3-month, and 6-month tenors. Not all of the banks would follow Goodman’s suggestion all of the time. But most of them would take Goodman’s email as an important datapoint, and some of them would simply turn around and submit whatever Goodman told them the rate was. After all, yen Libor was, especially during the financial crisis, something of a fiction: it’s meant to represent the rate at which banks lend to each other in yen, but by the time of the crisis, there was exactly zero interbank yen lending going on. So yen Libor became simply whatever the banks said that it was — a recipe for manipulation.

The biggest manipulator of all was Tom Hayes of UBS, who was criminally charged back in June. Hayes made millions for UBS by entering into derivatives bets about where Libor was going to be. And he tended to win those bets not because of some unusual degree of prescience, but rather because he would tell ICAP where he wanted Libor to be, and then Goodman would put those numbers into his email to the various fixing banks. Essentially, ICAP made money by knowing what Hayes wanted, and then delivering it to him.

Hayes’s trades were very profitable not only for UBS, you see, but also for ICAP. Libor derivatives don’t trade on any exchange: they’re entered into bilaterally, between various institutions. And in the middle, taking no risk but bringing the different institutions together so that they can trade, sit the inter-dealer brokers like ICAP. Hayes didn’t use ICAP exclusively — he had a similar arrangement with Tullett Prebon — but he used ICAP a lot, and every time he traded through them, they would take a commission. On top of that, ICAP had an implicit deal with Hayes that in return for getting him the Libor fixings he wanted, he would be willing to face their other clients on unrelated trades. Essentially, if somebody phoned up ICAP looking to do a derivatives deal, they knew that Hayes would be there for them, at something approaching the market price, and would provide the liquidity the market needed.

There’s a lot of pretty funny internal ICAP politics in the complaint. Because Hayes was a derivatives dealer, his commissions went to ICAP’s derivatives desk — rather than to Goodman, who was on the cash desk. As a result, both ICAP and Hayes had to contort themselves to find some way to pay Goodman for his services. It turns out that Goodman was selling himself pretty cheap: he seemed to be satisfied with an extra £5,000 per quarter. Plus whatever “kickbacks” Hayes paid him directly. (Those, sensibly, weren’t discussed directly over email, although they were referred to: “As for kick backs etc we can discuss that at lunch and I will speak to Tom about it next time he comes up for a chat,” wrote Wilkinson to Goodman.

The world of inter-dealer brokers is one of the most lavish on Wall Street: deals are commonly lubricated with expensive meals, Champagne, tickets to sporting events or Las Vegas — even nights out at Lady Marmalade Adult Parties. The brokers don’t take on any risk, but they still get paid enormous sums — and the way they get the money is by persuading the big traders on Wall Street to use them rather than some competitor when putting together trades. If that involves staying up all night blowing rails, then that’s what the inter-dealer brokers are going to end up doing.

So while ICAP’s behavior here was particularly egregious, and probably criminal, there’s something endemic to inter-dealer brokers which is deeper and more troubling. The New York attorney general is worried about what he calls “insider trading 2.0″, where small groups of traders have information a few milliseconds before the rest of the market. But in the world of inter-dealer brokers, there’s really no such thing as public information at all: all trades are private, all information is private, and the way to make money is entirely a function of what connections you have and whom you’re able to befriend over the course of long evenings of lavish entertainment.

Or, to put it another way, ICAP’s (alleged) criminality is basically just an extension of its core business — which is dealing in information asymmetry. ICAP’s brokers know who wants to trade what, in which direction — and they use that information to make risk-free profits. In the case of Hayes, it looks very much as though they crossed a criminal line in doing so. But the bigger scandal, in many ways, is the amount of money they can make entirely legally, by monetizing information which they have and which no one else possesses. Shouldn’t Eric Schneiderman be worried about that?


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Felix – please let me know when you start selling “Lord Libor” t-shirts. I want one.

Posted by KidDynamite | Report as abusive

Hmm … isn’t what these guys appear to have done trivial in comparison to what HSBC was allowed to walk away clean from? And we all do recall the perfect justice of that, as explained to us by a certain blogger, don’t we?

What’s the point of even talking about things like this any longer?

Posted by MrRFox | Report as abusive

I’d like to see how this compares to the trading irregularities om Chicago regard the Fed and the Taper.

Someone traded the instant the news was announced, but as they were in Chicago, they so got a 7 millisecond head start courtesy of the speed of light, and conducted $600m worth of trades.

Posted by Matthew_Saroff | Report as abusive


here’s a good post on that total non-story:  /eric-schneiderman-wall-street-time-mac hine-sheriff.html

Posted by KidDynamite | Report as abusive

As between KidD, a certain blogger, and Matt Levine – who’s the biggest Wall Street shill?

“Non-story”, Kid – $600-million put on the table in a few micro-seconds? This isn’t a couple of wise guys bribing some low-rent scribe, ya’ know. Most plausible, the tip had to come from inside the Fed, and be passed on to someone with real sway on The Street.

There is a ‘paper trail’ – easy enough to find out, if rabbi Lew cares to do so, who placed the offending trades; from there it’s just a matter of sweating the truth out of whoever that was until he spills the truth about where the tip came from. “Non-story” – IDTS. An ugly story our conflicted masters in DC don’t care to pursue – that’s more the ticket IMO.

Posted by MrRFox | Report as abusive

@MrRFox –

there are people who understand the mechanics of markets – people like Matt Levine and myself – who understand why this is a non-story.

then there are people who don’t and are looking for useless populist lynch mobs.

of course, Levine explained this all in his post. I also explained it in a post Levine linked to. The answers are all there if you really want to understand reality instead of looking for an enemy to blame.

good luck.

Posted by KidDynamite | Report as abusive

KiddoD, like Matty (‘I love The Street’)Levine, does everything but address the obvious fact that somebody had to have received advance knowledge of the Fed’s decision – there is no other plausible explanation for the sequence of observed trades.

The preferred cover-story is that it must have been those naughty reporters who jumped the gun – not likely, IMO. They were limited to a small group and kept in a locked room. Far more people within the Fed itself knew of the decision, and nobody kept them under lock and key.

Somebody who had the capacity to put $600-million on the table, via direct computer-link to the Exchange, and have the order executed within the space of a few thousandths of a second knew what was going to happen before it was announced. That has to be somebody big in NYC, and those guys are much closer to folks at the Fed than they are to any of blabber-mouth reporters; they should be – NYC rabbis made all of them rich.

Posted by MrRFox | Report as abusive

I guess there is a broader question here, Felix. Is it legitimate to have a purely private investment market? And variables that are privately determined? Where all business is “Enter/Use at your own risk?”

We have a concept like that regarding accredited investors, for both sophisticated individuals and corporations. What’s happened here and in other places where you have “fixes” in the market price, is that the market has gotten so big that the position of the fix affects a wide number of players, and the variables affect some non-sophisticated players (e.g. an adjustable rate loan that floats off LIBOR).

I wrote an article on this a while ago: nal-indexes-like-libor/

Now obviously, my opinion has been wrong with respect to how the tide of public policy has moved. My point is this: you can dig into a large number of complicated situations, and probably find someone taking advantage of information asymmetries. Is he a trader, an arb, or a felon? If a felon, there are going to be a lot of surprised people who though they were just making an internal market.

As always, I appreciate your work.


Posted by DavidMerkel | Report as abusive

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