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Barclays Scandal Was Born of Diamond's Derivatives Bet

Stocks in this article: BCS GS JPM MS C

But, after taking on nearly 10,000 Lehman Brothers employees, Diamond's mission for Barclays Capital changed. No longer interested in just dominating "risk management" - a Wall Street euphemism for derivatives - Diamond wanted Barclays Capital to become the "top global investment bank," meaning it would grow its debt and equity underwriting and investment banking advisory businesses to take on more white-glove operations like Goldman Sachs.

For instance, Barclays Capital provided most of the financing for Kinder Morgan's (KMI) takeover of El Paso (EP), in a front-page deal that it would not have won without former Lehman Brothers investment bankers.

It's those two phases of Barclays Capital, which may underscore the importance of Diamond and Del Missier's resignations. While they've successfully transformed Barclays Capital into a leading investment banking presence, it was their early reliance on hard-to-manage and opaque derivatives trading based earnings that may be their downfall and a cautionary tale.

Testimony prepared for the U.K.'s Treasury's Treasury Select Committee may signal that Diamond was adjacently involved with Barclays manipulation of Libor, a benchmark interest rate that is used for most variable rate debt and is the staple of the $350 trillion swaps market. According to the testimony and revelations from regulatory settlements, Diamond and top Barclays Capital executives like Del Missier may have inadvertently signaled for traders to underreport their borrowing costs after communications with the Bank of England in October 2008.

The resignations appear to center on a correspondence between Diamond and a Bank of England deputy Paul Tucker, where the official signaled 'senior' officials at the Central Bank felt that Barclays was reporting borrowing costs that were too high relative to peers and that the bank could lower them. "Tucker stated that the levels of calls he was receiving from Whitehall were 'senior' and that while he was certain we did not need advice, that it did not always need to be the case that we appeared as high as we have recently," wrote Diamond in an Oct. 30 email to former CEO John Varley that Barclays released on Tuesday.

While the bank stated that Diamond didn't think the correspondence was an explicit instruction to report artificially low short-term borrowing costs, Barclays said on Tuesday that "Jerry del Missier concluded that an instruction had been passed down from the Bank of England not to keep LIBORs so high. He passed down an instruction to that effect to the submitters."

Even if the ongoing inquiry into Barclays' Libor manipulation doesn't draw Diamond or Del Missier into the fray of allegations or prospective criminal probes, revelations from its settlement with regulators in the U.S. and the U.K. definitively show that some of the bank's traders were involved in repeated attempts at market manipulation over a span of years.

The fines also show that traders acting in OTC markets with limited oversight can cripple a banks reputation. JPMorgan's 'London Whale' trading loss also stands as another cautionary tale of derivatives trading run amuck.

Just days ago, in an internal memo obtained by Bloomberg, Diamond said that the banks' $450 million settlement with regulators was the making of "the action of a few people" within its interest rate swap trading units, mostly between 2005 and 2007. A week ago, the fine and Barclays' statements underscored how hard it is for bank CEO's to manage traders in opaque markets like derivatives.

Now, the resignations of Diamond and Del Missier and widespread uncertainty over who will lead Barclays show that risks can be even greater.

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