The Wheatley Review looks to the CFTC for LIBOR methodology

The Wheatley LIBOR review made reference to the order that Barclays entered into with the CFTC. They liked the CFTC methodology used to determine LIBOR so much that the review authors recommended other banks follow the same protocol. 

Section 4.9 of the review said, “…These submission guidelines are closely modelled on the undertakings proposed by the Commodity Futures Trading Commission (CFTC) in their settlement with Barclays Bank Plc. It is the view of the Wheatley Review that banks should begin to create their LIBOR submissions by taking account of these guidelines immediately…”  So what is that process?

Below is a section from the Wheatley final report that outlines the data that Banks should consider when figuring out what rates to submit. It is based off the protocol mandated in the CFTC order.

A couple things are interesting to us. First, it is acknowledged that while the contributing bank’s actual transactions are to be the primary driver, observations of third party actual transactions, quotes by third parties, and finally expert judgement (in that order of priority) can be included too. For all the commentary that expert judgment is so subjective and, well, malleable, it is still part of the equation. When markets are so thin, traders do what they do: come up with a price based on the facts they see around them and their opinions.

The second item worth noting is that there were lots of other things to look at besides inter-bank deposits. CDs, CP, OIS, Repos, FX forwards, interest rate futures, options and central bank operations. A number of these instruments are centrally cleared in CCPs. As such, they have mitigated counterparty risk. It was the counterparty risk that, during the financial crisis, caused inter-bank lending to grind to a halt. For many, pre-crisis inter-bank deposits were considered a risk-free instrument. But afterwards, the credit component was seen as LIBOR’s Achilles heel. Is this an acknowledgement, albeit roundabout, that the credit risk component of LIBOR might be a problem? We think that in the long run, whatever LIBOR evolves into or other benchmarks emerge, they will have to be as counterparty risk neutral as possible

A link to the Wheatley Review is here.

A link to the CFTC order is here.

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