Earlier this week, the European Commission (EC) formally charged JPMorgan (NYSE:JPM), HSBC and Crédit Agricole with breaching EU antitrust laws by rigging benchmark interest rates. ((Antitrust: Commission sends Statement of Objections to Crédit Agricole, HSBC and JPMorgan, EU Website, May 20 2014)) The charges, which were conveyed through a statement of objections to each of the banks, were hardly unexpected as these three banks and the cash broker ICAP had dropped out of settlement talks over rate-fixing with the EC late last year.  The EC imposed fines of €1.71 billion ($2.33 billion) on eight global banking giants last December, after an initial investigation (see EC Hands Down $2.3 Billion In Fines To 8 Banks For Rigging Benchmark Rates).
We believe that the decision by the three banks to turn down settlement offers last year was a gamble with a limited downside risk. This is because the fines proposed by the EC were based on preliminary findings, and these three banks maintain that the EU has insufficient evidence to charge them. Accordingly they are taking their chances on a full investigation – hoping to be cleared of the charges without a penalty.
Since Barclays (NYSE:BCS) was found guilty of manipulating LIBOR in June 2012, regulators around the world have pursued a string of investigations into the world’s largest banks to understand their role in the rate-rigging scandal. After all, LIBOR, EURIBOR and TIBOR are used by institutions around the globe to price trillions of dollars worth of securities each day, and these rates affect everything from the value of derivatives to even the interest rates on retail loans and mortgages. The scandal has cost the banking sector no less than $6 billion in fines over the last two years – with billions more at risk from continuing investigations by financial regulators, as well as from class-action lawsuits by institutional and retail investors. 
The EC was one of the first regulators to begin investigating a group of 10 banks and a cash broker for manipulating the benchmark rates. A quick investigation led to the EC dividing the banks into two groups based on their involvement in determining benchmark rates for the euro and Japanese yen (with some of the banks figuring in both groups). The regulator then held a round of talks, handing out fines to the banks based on their level of involvement as well as their cooperation in the investigation (full details about the settlement are in our article here).
But JPMorgan, HSBC and Crédit Agricole held out from the settlement, choosing instead to face a full investigation. The decision is understandable considering the magnitude of the payouts involved. Although the EU has the power to impose a fine of up to 10% of a company’s annual turnover if it is found guilty of infringing antitrust laws, in the worst case scenario, the banks would be expecting a fine of around what they were asked to settle for initially. The 10% discount to the fine amount which accompanied an early settlement clearly wasn’t a good enough incentive for any of these banks to settle – especially when there was a possibility that they could get away without a fine. JPMorgan’s decision to challenge the euro-related charges even as it settled its involvement in the yen scandal for $109 million only lends more support to this thought. So does the fact that all three banks continue to believe that the EU doesn’t have enough evidence.
What remains to be seen is which way the gamble tilts over the coming months. If the decision goes against JPMorgan, the bank could end up paying as much as $500 million in penalties to the EU, and will also be more vulnerable to subsequent lawsuits which will draw on the EU’s investigation results. Higher legal costs related to the rate-rigging scandal can impact JPMorgan’s share price by dragging down margins for its investment banking division. You can understand how the bank’s investment banking margins affects share value by making changes to the chart below.Notes:
- Antitrust: Commission fines banks € 1.71 billion for participating in cartels in the interest rate derivatives industry, EC Press Releases, Dec 4 2013 [↩]
- EU Commission charges HSBC, JPMorgan, Credit Agricole with rigging, Reuters, May 20 2014 [↩]