Following the release of another 80 pages of emails from the Bank of England on what they knew and when on fake or dubious LIBOR submissions, regulators have taken a big hit on being too lax on LIBOR in 2008. The Wall Street Journal for example published a story on Friday July 20 saying that the Bank of England “rebuffed calls for stronger oversight of the interest-rate benchmark at the center of a global scandal.” But who was really responsible for making sure that LIBOR was right: the Bank of England, the British Bankers’ Association (BBA), or everyone who was actually using LIBOR as a benchmark.
There is no question that LIBOR, a voluntary benchmark created by the British Bankers’ Association, was flawed. The biggest problem is that LIBOR is set on indications of interest (IOIs), not actual transactions. We have a lot more to say on that note and will be releasing a research report shortly on the topic of LIBOR and its alternatives. The IOIs of one bank or another can be manipulated – just ask anyone who has ever entered an IOI into one of Thompson’s AUTEX platforms. In equity markets, no one would dream of using an AUTEX index as a benchmark for a multi-million dollar equity swap. Instead, the actual transaction price on a stock exchange would be used.
But, for lack of anything else or the fact that the rules were rigged in favor of banks, LIBOR emerged as the industry standard for OTC derivatives and a host of other benchmark uses. Helping to set LIBOR rates while trading on LIBOR was a great deal for banks who knowingly manipulated the rates to suit their P&L. The Barclays example of the trader who asked for a lower submission as they had a large trade on is a prime example. For counterparties, LIBOR was assumed to be legitimate, and it will be left to the many emerging lawsuits to determine whether buyers were duped or should have done better due diligence into the terms and benchmarks used in their contracts.
Back to the Bank of England: should it have taken an active role in 2008 overseeing both actual submissions and the methodology of LIBOR? As a voluntary benchmark, LIBOR relies on the accurate submissions of its panel members from each participating country. Regulators have shown that they are responsible for making sure that banks submit accurate IOIs to LIBOR. Underneath accurate submissions however is whether the methodology of setting LIBOR, or even using LIBOR itself, was accurate. This is where the papers are hammering on the BoE.
The BoE’s own emails show itself in the middle of the BBA and the US Federal Reserve on whether to actively supervise the LIBOR methodology or not. The Federal Reserve advocated a stronger stance towards the setting of LIBOR and the composition of the different member panels, particularly the US panel. The BoE seemed almost unsure of whether to go after the BBA and force its hand or allow the private market to use whichever benchmark it wanted, and let that benchmark be set accordingly. The BBA wanted no effective changes, as noted in a BoE email that certain member panel compositions hadn’t changed at all after a recent BBA review. At the same time, the BBA asked the BoE to take over supervising LIBOR, and the BoE declined. As the WSJ noted on Friday:
“The [LIBOR] controversy deepened Friday when the BBA issued an unusual public statement casting further blame on the Bank of England. The BBA said it asked the central bank to take on a formal role overseeing Libor in order to help address questions about its governance.
“But the Bank of England declined the invitation, according to the BBA statement and a person familiar with the central bank’s thinking. In a statement accompanying the disclosures, the Bank of England said, ‘Because the Libor system was, and is, a private sector arrangement and was not subject to financial regulation, it was not appropriate for the public authorities to endorse or determine the outcome of the BBA review.'”
The question of whether the BoE was right or wrong to decline supervision has important lessons for today. Not only will it affect the next likely Governor of the BoE, but the criticism also suggests that regulators will be more careful to supervise other commonly accepted market benchmarks in the future. IN 2008, there was a legitimate argument for the BoE to say that LIBOR was an arrangement between two market counterparties and that regulators should not necessarily be involved. In 2012, regulators see that they need to be much more proactive in looking out for the needs of investors, even supposedly smart institutional investors.
A link to the BoE’s July 20 2012 release of emails on LIBOR in 2008 is here.