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Barclays Scandal Was Born of Diamond's Derivatives Bet

Now, Diamond's Tuesday resignation puts the bank potentially adrift. For other banks, risks may be equally large if regulatory inquiries lead to upper management departures.

The revelations of Barclays' manipulation of key benchmark rates known as Libor and Euribor may have an even broader market importance, notes Richard Bove, a banking analyst with Rochdale Securities. "Today, there is no base rate to set loans," he says, pointing to the doubts that the Barclays probe casts on the process of setting of short term interest rates. Still, Bove sees the interest rate swap market's continued growth as proof that it has a utility in finance.

According to a $450 million regulatory settlement with the Commodity Futures Trading Commission, the U.S. Department of Justice and the U.K.'s Financial Service Authority agreed last week, Barclays traders and employees responsible for determining the bank's LIBOR and Euribor funding costs attempted to manipulate and falsely report benchmark interest rates to bolster profits or minimize losses on derivatives trades. Starting in 2005 Barclays's manipulation "occurred regularly and was pervasive," said the CFTC in its settlement order.

Already, the process of setting the rates, which is governed by the British Banking Association, has been criticized as being too opaque and giving far too much power to the world's largest banks. Banks are polled on the costs to borrow from each other in different currencies like the dollar, yen, euro and Swiss franc for 15 different periods, from overnight to one year. Some high and low quotes are excluded, with remaining bids averaged and set by the BBA.

Meanwhile, a manipulation of the rates may have unfairly impacted the borrowing costs of homeowners, governments and corporations around the world, as Barclays and others allegedly tried to profit or curb losses tied to floating interest rates at the height of the financial crisis.

Regulators around the world, including the Department of Justice, Financial Services Authority and other Japanese and European agencies are investigating other allegations manipulation of the setting of the benchmark rates, which are a key part of opaque derivative markets that have roughly $350 trillion in outstanding market value.

-- Written by Antoine Gara in New York
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