046_Global12_Arena_V7

Global issue 12

Arena LIBOR Decoded LIBOR: a global credit benchmark in need of a radical overhaul What is LIBOR? naed Deutsche Bank, Citigroup, JPMorgan Chase, Royal Bank of Scotland, HSBC and UBS in relation to LIBOR manipula- In the mid-1980s, borrowing by one bank from another in the un- tion) has shown how some banks allowed their submissions to secured inter-bank money market was a well-established way of the BBA panels to be influenced directly by in-house traders or smoothing the holding of funds while satisfying the liquidity require- senior staff of the bank, causing them to alter their initial as- ments that were intended to reduce the risk of a bank run. LIBOR sessments. (the London Inter-Bank Offered Rate) was developed as a market- A LIBOR quotation would at times be varied to influence a rate based measure of international lending costs to replace the use of US for a particular currency, so that it would directly or indirectly af- Treasury Bill rates, which were perceived as too volatile and subject fect the overall rate. There was also informal complicity between to distortions. LIBOR now provides a set of daily updated bench- traders in different firms to influence the LIBOR submissions of mark interest rates that reflect the cost of inter-bank lending in ten different banks. The intention was to change the targeted LIBOR different currencies and for different time periods. Administered by rate by a few basis points so that an in-house position in a trade was the British Bankers’ Association (BBA), it is calculated and released more profitable. in London by Thomson Reuters at 11 a.m. each working day. Notably, at times of severe money market stress for the banks in LIBOR is the reply to the following question to each member of 2008, quotations were apparently reduced so as to allow the bank a currency-specific BBA panel of banks: “At what rate could you concerned to appear to be receiving stronger market endorsement borrow funds, were you to do so by asking for and then accepting for their creditworthiness than was in fact the case. It was the inter-bank offers in a reasonable market size just prior to 11 a.m.?”. last type of influencing that brought LIBOR manipulation to the The panels consist of between 6 and 18 major banks selected by attention of the US regulators in 2008 when, following the Leh- the BBA’s Foreign Exchange and Money Markets Committee on man crisis, Barclays complained that other submitters were un- the basis of their scale of activity in the London market, perceived derbidding on LIBOR to make their banks appear (falsely) more expertise in the currency concerned and credit standing. Each cur- creditworthy than they were – something that the US Treasury rency panel’s highest and lowest submissions are discarded, with the brought to the Bank of England’s attention, who in turn referred remaining submissions averaged to fix LIBOR for the given day. the query to the BBA. How is it supposed to work? What happens to LIBOR now? LIBOR benchmark rates are intended to be objective, accurate and up-to-date measures of borrowing costs for banks in particular cur- LIBOR continues as the core benchmark for international con- rencies and for different terms. LIBOR spreads – across currencies tracts and derivatives. Litigation over contracts affected by the and over time frames – are widely used indicators of currency ex- LIBOR manipulation, criminal fraud investigations and fur- change risk and economic uncertainty. They are used in over $300 ther large fines from regulators for other banks involved look trillion worth of global financial contracts that underpin trade and inevitable. investment. A UK Treasury review led by market conduct regulator Mar- From its inception, LIBOR developed rapidly as a reference tin Wheatley reported in September. Known as the Wheatley benchmark for commercial mortgage contracts and then for deriva- Review, this proposed to replace the BBA as the administrator tives trading, the latter rapidly overtaking LIBOR’s original role in of LIBOR with an independent private party in order to bring lending markets. LIBOR benchmarked values have now become an both the submission and administration of LIBOR into explicit integral reference for a huge volume of financial contracts. Small regulation by the Financial Conduct Authority, and to extend changes in the LIBOR rate can have significant consequences for proposed market abuse regulations to cover benchmark indices the benefits and costs to counterparties in these contracts. like LIBOR and Euribor, its European equivalent. The Review’s However, since 2009, regulators and public authorities in the focus is on reform of the existing system – which remains mar- USA, Canada, Japan, Switzerland and the EU have been inves- ket-led – and practical procedures to learn lessons and minimise tigating alleged misconduct relating to LIBOR and other global the possibilities for future manipulation of the benchmark. It credit cost benchmarks. Recent evidence published by US and UK recommended the use of transaction data and other corrobora- regulators shows that between 2005 and 2009, LIBOR submissions tive approaches, but recognised that this will not be straight- by some panel member banks of the BBA were manipulated. This forward given the low volume of inter-bank transactions in was to benefit their trading positions or image. The evidence is particular currencies and tenors under the current LIBOR defi- deeply damaging to the LIBOR benchmark, the reputation of inter- nition of inter-bank lending. For this reason, it proposed to re- national investment banks and the process of regulation. duce the range of coverage of the benchmark. There was a call for improved governance and culture in banking practices to How were the ratings rigged and how was this discovered? go alongside the introduction of criminal sanctions for market manipulation. Evidence recently presented by the regulators in the case of Barclays (the only bank so far to admit complicity, although Saxon Brettell, Director, Piametrics in August the New York attorney general reportedly subpoe- 46 lwww.global-briefing.org fourth quarter 2012global


Global issue 12
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