The ICE people responsible for LIBOR (ICE Benchmark Administration Limited or IBA) have published a new paper, “Second Position Paper on the Evolution of ICE Libor”. So what is IBA thinking about?
IBA noted the following changes have already been instituted, with positive results:
- The introduction by the UK authorities of statutory regulation for the administration of, and submission to, LIBOR, including an Approved Persons regime, to provide the assurance of credible independent supervision, oversight and enforcement, both civil and criminal
- The appointment of IBA as an independent administrator with dedicated resources
- IBA’s robust governance structure which includes a Board with a majority of Independent Non-Executive Directors and a LIBOR Oversight Committee
- Implementation by IBA of a bespoke surveillance system, with a dedicated team that assesses the credibility of submissions and seeks to identify breaches of submission standards and tolerances through a combination of alerts and pattern-matching
- Governance and control mechanisms established within the panel banks
- The FCA requirement for each panel bank to have an individual who is personally accountable for the bank’s LIBOR submission activity, and
- External auditing of the administrator and submitters.
The paper, which is more of a consultative document than an explanation of findings, asks a variety of interesting questions. Using transaction-based data means a transparent set of rules to determine which data is used. But adopting strict formulas may result in distortions.
The IBA has a number of topics they want addressed by respondents to see where they stand. We take a look at a handful of them.
Some have questioned if trades with corporates should be included. The issue looks to be two-fold:
“…First, corporates’ transaction sizes may be smaller than interbank trades have traditionally been and, second, the pricing may differ from interbank dealings…”
IBA wants to know if corporate trades should included at all, should there be some sort of adjustment (either a premium or discount) to the rate those trades are reported at and should there be a minimum threshold for corporate deals?
The timing of when to collect rates and publish them is at issue. The four permutations are:
- Using trades starting from the time of the bank’s pervious LIBOR submission and going to the next deadline (i.e. trades executed just after 11am until the following 11am). LIBOR would then be published at 11:45am, as it is now.
- Using data from only the prior day. This avoids crossing value dates and gives banks more time to validate their numbers. However it creates the possibility of stale levels given the one-day lag.
- Using data collected during an extended day (6:00am to 1:30pm) then publishing LIBOR at 2:15pm. This still risks stale data being used, but IBA suggested it was less likely than the prior two options.
- Collecting rate data from the prior rate submission, but submitting a rate valid as of 11am the day of submission. If necessary using expert judgment to determine the 11am rate. This results in LIBOR being current as of the publication time, but may reduce the use of actual transaction data to drive the submission.
Some of the questions IBA had included:
- Which method is preferable?
- Which methodology respondents think will be best and why?
- Will there be implementation problems, should LIBOR be determined as a point in time or by reference to a period of time?
- If a point in time, what time?
- If a period of time, what period is optimal?
- Should the window be the same for all products (e.g. derivatives, options, loans, etc.)?
The IBA wants to standardize the types of transactions that go into determining a submission, using a volume weighted average price from unsecured deposits, primary issuance CP, primary issuance CDs, and, if necessary, primary issuance vanilla floating rate notes (FRNs) or floating rate CDs (FCDs) with maturities of less than 2 years.
IBA wants to know if respondents are ok with including FRNs and FCDs to supplement the other data and if there are any other types of transactions that should be included.
If actual rates are used to determine LIBOR, this means that certain unrepresentative transactions might be included and skew the data. The IBA wants to know if the raw data should be used with no adjustments to, in effect, undo the unrepresentative nature of the trade.
The minimum transaction size to be included in the data set is important to the IBA. If set too low, it can dilute the wholesale nature of the index. Too high and LIBOR can be manipulated more easily. Thresholds may differ across maturities and currencies, too. IBA wants to know what respondents think about this. What are the right levels?
The use of expert judgment is controversial. It opens the rate to manipulation. But when there isn’t good data to use – either because the market is now unrepresentative or the respondent has had a change in their funding rates — expert judgment can fill the gap. The IBA wants to know if expert adjustments are appropriate under these circumstances?
Each bank must have robust governance of how and when expert judgment is used in lieu of actual or implied data. The exact same rules, according to the IBA, should not be across every institution for fear that the rates could be predicted by other market participants and easily manipulated.
In this post we have not looked at each topic the IBA brings up. While most agree than a bias toward actual transactions is a good thing, the issues get complex quickly. IBA is heading in the right direction, but this is a public process with lots of political ramifications. We don’t envy IBA threading this needle.