Monday, 28 May 2018

Finally, some sense around Libor reform

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Wheatley’s plans are welcome – but some flaws remain, says IFR editor-at-large Keith Mullin

THE FINAL REPORT of the Libor review was a breath of fresh air and Martin Wheatley should be commended on moving quickly to a very reasonable final set of recommendations to the UK Treasury. Yet in so many ways the 92-page report was little more than a study in stating the obvious.

The chief executive of the incoming Financial Conduct Authority certainly didn’t beat about the bush at the launch of his report on Friday.

“The reason we are here,” he reminded us, “is that we have been misled. The system is broken and needs a complete overhaul. The disturbing events we have uncovered in the manipulation of Libor have severely damaged our confidence and our trust – it has torn the very fabric that our financial system is built on.” A bit histrionic, maybe, but punchy nonetheless.

The one clear outcome from what otherwise is a logical set of recommendations is that the British Bankers’ Association will be fired as the administrator and compiler of Libor in favour of a body that will provide “credible internal governance and oversight”. That, in particular, is a good shout. The BBA’s handling of the Libor reform process has been a disgrace and the organisation has shown little real intent in fixing the flaws in the current system, which have been apparent for years.

The fact that the two BBA sub-committees looking at unresolved problems and disciplinary procedures hardly ever met led Wheatley to infer “a careless approach that did not place enough emphasis on the importance of Libor from both a governance and regulatory perspective – essentially, people had an overt level of trust in a system that did not have the right level of checks and balances in place”. Well said.

SO, WHAT OF the key recommendations? Well, statutory regulation of the process and criminalisation of rate-rigging – against a broadening in the application of current market abuse legislation – will ensure that the arrogant morons who sit on trading desks and do try and rig the benchmarks to suit their trading positions won’t just be dealt with by disinterested internal supervisors, if at all. It’ll take the process away from matters of internal culture and governance to matters of police investigation and potential custodial sentences. That’s a good start.

The BBA’s handling of the Libor reform process has been a disgrace

Wheatley also recommends the UK regulator be given new powers of compulsion, to be used particularly in periods of market stress or where insufficient corroborating data is available, to ensure a benchmark is calculable. At present the system of submissions is completely voluntary.

He wants banks to submit rates on the basis of actual transactions to corroborate their submissions. He came as close as he could in the current circumstances to ensuring that banks do use trade data. This is at the heart of the recommendations. I’ve long been arguing that actual data have to be the essence of successful benchmarking, along with robust record-keeping and regular external audits.

Clearly, there are issues in using actual rates – absence of sufficient transactions; timing (11am Libor fix vs end-of-day overnight cash depo-rate fix); costs of setting up and maintaining a trade repository, etc – but I must say I’m disappointed that Wheatley didn’t push more resolutely towards a transaction-based model. He did leave the door ajar by saying that if unsecured interbank lending revives, such a system could be re-considered. I would have liked to have seen a more formal transition timetable.

Other recommendations were generally sound. Submitters should use their experience of the interbank deposit market and its relationships with other markets to prepare submissions, ie, not just unsecured interbank deposit transactions but CD and CP markets, overnight index rates (Sonia, Eonia etc); OIS, repos, FX forwards, interest-rate derivatives and central bank operations.

This suggests that submitters will need to use common sense, judgement and awareness, particularly if they need to interpret, interpolate or extrapolate. I can see problems in this regard in that this may divert attention from what is a relevant unsecured interbank lending rate to a rate that represents some broad-based market sentiment benchmark, but in a relative world, I guess everything’s relative.

TO AVOID THE potential stigma of banks submitting high rates during periods of market stress and bringing self-destructive rumours on themselves, Wheatley recommends that individual submission rates should only be published after three months. To make up for the lack of granular real-time data, the new Libor administrator should publish a regular statistical bulletin detailing the state of the market using data from contributing banks and including the volume and value of relevant interbank transactions and other related financial instruments.

If there are insufficient trade data across the full range of currencies and tenors to corroborate submissions, the BBA should cease publication of those rates. Specifically, Wheatley says that Australian dollar, Canadian dollar, Danish krone, New Zealand dollar and Swedish krona data should be discontinued altogether; ditto rates for four, five, seven, eight, 10 and 11 months in all other currencies. He recommends overnight, one-week, two-week, two-month and nine-month Libor rates be considered. This would cut daily published benchmarks from 150 to 20. In their place, market participants could use domestic benchmark rates.

On the basis that there’s nothing contentious in the final report, I look forward to seeing the recommendations implemented at the earliest opportunity.

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