Legal Update: Chasing their losses

In all the news coverage of banks manipulating key financial market benchmarks such as Libor and ISDAFIX, little has been said about the impact on the insurance industry.

Yet, it is highly likely that the scandal caused more damage to insurers than to any other type of asset manager. Furthermore, there may be a legal imperative on them to investigate the losses.

Insurers are the biggest investors in European markets, holding and managing assets equivalent to approximately 58% of the European gross domestic product. They, therefore, have exposure to all kinds of interest rate-affected products, including bonds, loans and derivatives. Consequently, they are likely to have been significantly damaged by manipulation of the Libor and the ISDAFIX.

Not many seem aware, however, that the law requires that if such damages are creditable, and pursuing them is cost-effective, insurers have a positive duty to seek recovery on behalf of policyholders, investors, shareholders, clients and customers.

But how do they gauge how much they might have lost? In short, using information uncovered by regulatory investigations, and from analyses of the relationship of Libor and the ISDAFIX to other, un-manipulated financial markets, it is possible to see how much money the market manipulation cost insurers.

Libor manipulation
We know, for example, that Libor was distorted downward by eight basis points between 2007 and 2009, according to a recent study. This means that, during that time, the beneficiaries of transactions paying revenue indexed to Libor would be: £8000 poorer if the total principal of transactions was £1m; £8m poorer if the total principal of transactions was £1bn; and £8bn poorer if the total principal of transactions was £1trn.

According to the International Monetary Fund, around $300trn (£1.95trn) in financial contracts are tied to Libor. Consequently, manipulation of Libor could have been costing market participants more than $2trn in revenues a year.

With insurers controlling assets representing around 58% of the European GDP, they suffered colossal losses – perhaps hundreds of billions of dollars.

ISDAFIX manipulation
The losses involved in the ISDAFIX manipulation are similarly mind-boggling.

According to Bloomberg Business, a distortion of the ISDAFIX by one basis point can generate $1m in extra profit for the dealer on a $500m swap that matures in 20 years. That is a $1m loss for a counterparty to an interest rate swap agreement.

Industry-wide investigations in the US and the UK continue, but many of the counterparties suffering losses were likely to be insurance companies. And, in an interest rate swaps market worth about $400trn annually, the total losses must be staggering.

Duty to act
Yet many insurance company asset managers have been slow to react. It is not just that they are missing an opportunity to recover damages. They could also be leaving themselves open to the accusation that they failed in their duties to pursue credible and cost-effective claims on behalf of policyholders, shareholders and other stakeholders who lost out from the benchmark manipulation.

What is more, gauging the magnitude of losses from benchmark manipulation may not require significant financial investment given that regulatory investigations have already uncovered much of the necessary information and, importantly, resulted in admissions of guilt.

With this information available, insurers need to identify their losses, and get that money back from the market manipulators.

Dr Edward Swan
Partner, Elborne Mitchell