On February 26th the CFTC had a roundtable discussion on bechmarks. LIBOR was on everyone’s mind.
The discussion went out of its way to address benchmarks beyond LIBOR, but LIBOR was the elephant in the room. Chairman Gensler, in his opening remarks quoted BOE governor Mervyn King’s 2008 description of LIBOR “It is, in many ways, the rate at which banks do not lend to each other.”
Gensler’s opening remarks set the tone:
[“A] benchmark should as a matter of priority be anchored by observable transactions entered into at arm’s length between buyers and sellers in order for it to function as a credible indicator of prices, rates or index values.
I agree with the consultation report’s statement that for any benchmark to be reliable and have integrity, it’s best to be anchored in real, observable transactions. It’s only through real transactions entered into at arm’s length between buyers and sellers that we can be confident that prices are discovered and set accurately.
When market participants submit for a benchmark rate that lacks observable underlying transactions, even if operating in good faith, they may stray from what real transactions would reflect. When a benchmark is separated from real transactions, it is more vulnerable to misconduct.”
It is no shock that the lack of observable LIBOR-based transactions took center stage as a main reason for LIBOR’s weakness as a benchmark. Without a data repository it is hard to know volume and tenor (and that is part of the new LIBOR Administrator’s remit). But most people accept on faith that volume is a fraction of what it used to be pre-crisis. This has made LIBOR into something of a guessing game for traders. We wonder if the CFTC, as the primary regulator of the futures markets, expects the world to always have nice clean prices to observe. OTC markets are trickier and require an educated tri-angulation on occasion. Still, that is no excuse for fraud.
Some of the reasons given for the markets move away from unsecured funding were interesting. First, the revelation that LIBOR loans can be riskier than previously thought. Move along, not a lot new to see here. But the other causes: Central Banks offering cheap plentiful funding creating a substitute for LIBOR deals and the Basel III regulations, and specifically LCR, making it uneconomic to lend past 30 days, were a bit more food for thought.
A link to the press release is here.
A link to CFTC Chairman Gensler’s opening remarks is here.