The manipulation of the London Interbank Offered Rate (Libor) by many of the world’s largest banks resulted in a widespread loss of trust in the benchmark. Now the Intercontinental Exchange (ICE)—its new administrator—is seeking to regain that trust. Most recently, the exchange company issued a position paper discussing progress so far and proposing additional steps, which has made some corporate treasury executives a little concerned.
Libor is used to price a variety of loan and derivative products, and it is particularly relevant to companies pricing their commercial loans and derivative hedges. Numerous suits brought against the banks, including one brought earlier this year by the FDIC on behalf of several failed banks, allege losses stemming from the manipulation.
The ICE became responsible for Libor at the start of this year following its acquisition of NYSE Euronext, which has taken over administrative responsibilities from the British Banker’s Association. Finbarr Hutcheson, president of the ICE Benchmark Association (IBA), said the position paper ultimately has two goals, one of which is updating the definition of Libor, which has changed little since the late 1990s.
“You now have banks that source short-term funding from money market funds, sovereign wealth funds and large corporates. It’s not as straightforward as it was up until around 2006, when previously it was mostly interbank lending,” Mr. Hutcheson said.
The other goal is to clarify how Libor is calculated and create a system to ensure the benchmark stays current with market practice.
Mr. Hutcheson said so far, as described in the position paper, actions have been threefold. Libor is much harder to manipulate now because banks are now required to appoint an individual who is responsible for the accuracy of submissions, and each bank has established internal control processes to scrutinize each submission. In addition, attempts to manipulate the result are more likely to be discovered by the IBA’s independent surveillance team that is tasked with monitoring daily submissions. And thirdly, UK law now makes manipulating Libor and potentially other benchmarks a criminal offense potentially resulting in fines and even prison sentences.
The position paper also includes proposals to further improve the benchmark. Perhaps the most important one is an initiative to make banks’ submissions more objective. For example, banks look today at their money-market transactions to drive submissions, but one bank may include in the submission analysis only transactions over $10 million, while another bank’s threshold is $200 million.
“We’re still doing the analysis, but we might say all transactions over $50 million, for example, should be used in determining bank submissions. So the general thrust is less discretion for the banks, and less choice for them to say this one is relevant and that one isn’t,” Mr. Hutcheson said.
Under current thinking, in highly liquid markets where there are plenty of transactions to determine rate submissions, there would be a highly prescriptive rule set to follow. For less liquid markets, the IBA would provide pre-established interpolation methodologies to calculate rate submissions, and when there are no relevant transactions banks would be permitted to use their judgment, as they currently do.
Taking such a prescriptive approach on rate submissions for the most liquid funding, however, is a concern to London’s Association of Corporate Treasurers (ACT). Michelle Price, policy and technical director at the ACT, said that overly prescriptive rules can be problematic when markets are behaving in unexpected ways.
“You may need to take into context what’s happening in the market, whether there’s liquidity and other factors, to put forward your submission,” Ms. Price said, adding that even for submissions stemming from the most liquid transactions, “We believe judgment should always be allowed and is necessary.”
On the other hand, relying on an established set of rules to determine submissions could serve to help relieve banks from liability.
“There’s a significant benefit to Libor submitting banks, because it becomes a less risky proposition,” Mr. Hutcheson said. “There’s less chance that six months later, with the benefit of hindsight, regulators come back and say this was a poor choice, and take action against the submitter. That’s a difficult situation to be in.”
Any institutions using Libor or price debt instruments must license the benchmark. Comments on the position paper are due Dec. 19.