Can Libor be saved? The British Bankers' Association is certainly trying.
The group kicked off talks on Monday over whether and how to revamp the way borrowing rates between banks are calculated. The London Interbank Offered Rates serve as benchmarks for more than $350tn in contracts worldwide and help set the price of financial products, including mortgages and credit cards.
The review comes at what could be a watershed in the 25-year history of the BBA-sponsored indices. Dogged by repeated allegations that weak banks understated their borrowing rates during the financial crisis and facing competition from other indices, the Libor process is now under threat. At least nine regulators on three continents are probing whether banks, hedge funds and interdealer brokers colluded to push around Libor and similar rates set in Tokyo and Brussels. BBA officials have previously insisted that Libor rates “cannot be manipulated”.
Rate-setting banks submit daily estimates of how much it would cost them to borrow in 10 currencies for 15 different lengths of times. The top and bottom rates are thrown out and the remaining bids are averaged. But court documents filed by Canadian regulators say that a bank has turned over evidence that conspirators “were able to move yen Libor rates” to their benefit.
Beset from all sides, the BBA has announced a review. Some participants say they hope to have reforms in place by the summer. Angela Knight, BBA chief executive, says “This is the start of a process in which we will keep [regulators and the UK Treasury] fully informed and have proper structured discussions with market participants. We are committed to the continuing and ongoing evolution of Libor as appropriate.”
The BBA declined to comment on whether the talks would address the manipulation allegations. A previous review in 2008 led to the addition of more banks to the dollar rate panel as well the creation of an oversight board. In some markets, including interest-rate derivatives, the industry has already turned to alternative tools, including overnight indexed swaps (OIS), which involve exchanging a fixed rate for a benchmark overnight rate that can be used to discount collateralised derivatives.
Libor and the OIS rate used to trade closely together, but they split in 2007 as the credit crunch intensified. In 2010, LCH.Clearnet, the central counterparty for the interest rate swap market, officially began using OIS rates for valuing variation margins. “This was a big signal the industry had moved on,” says Fleur Meijs, a partner at PwC who has been advising on OIS discounting.
But some Libor panel banks would welcome a broader reworking. “Banks would love to be out of it entirely … What’s the upside of diligently quoting Libor in multiple currencies and tenors every single day? Zilch,” says an executive at a panel bank.
Traders say it is hard to imagine a world without the Libor rates. There is very little trading for periods beyond a month, but banks and customers need benchmarks for longer-term interest rate swaps. One government bond trader says: “If you want a figure for term interbank rates, you have to use the Libor survey because there are no or very few actual trades.”
Banks’ daily submissions to the Libor rates are public, with higher than average estimates often seen as a sign of funding stress. According Société Générale analysts, the dispersal of both dollar and euro Libor rate estimates is growing, with the variation of euro rates at levels not seen since late 2008.
Some analysts hope this review will remove the stigma associated with higher submissions. Rather than asking the bank what rate it could borrow at, they suggest, the banks should be asked what rate two banks would charge each other. But lending rates often depend on borrower quality so it is hard to calculate a generic rate.
Users and banks also say they would welcome tighter controls on who sets each bank’s estimate.
The BBA’s rules call for a named individual with responsibility for a bank’s cash to be responsible for submitting the daily Libor rates. But market participants say they believe that some banks allow a wider input. Employment lawsuits connected to the Libor probe allege that traders and even customers tried to put in requests for specific rate submissions.
A money markets trader at a European bank says: “More clarity on who is setting the rate would be a big help. But Libor is an opinion poll and not perfect. And so far no one has come up with a better way to set term rates.”
Get alerts on Capital markets when a new story is published