Tuesday, March 6, 2012

As investigation into manipulation of Libor continues, regulators consider overhaul

To no one's surprise, or at least not regular readers of this blog, the opacity surrounding the setting of the Libor rate allowed the big banks to manipulate this rate.

Even less surprising, now that the market's attention is focused on this manipulation, the financial regulators are considering how to overhaul the setting of the Libor rate while protecting both the banks' control of and the opacity of the process.

There is one simple solution to restore confidence in Libor rates while also eliminating the ability of the banks to manipulate this rate.

By requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, the data necessary to calculate Libor is readily available.

Libor is suppose to be a reflection of the average cost the banks incurred to access the credit markets.

With ultra transparency, the simple way to calculate Libor is to look at what it actually cost each of the banks to access the funding market and then, after eliminating the high and low cost banks, averaging the remaining banks.

With ultra transparency, all market participants could independently perform this calculation.  As a result, Libor is once again trusted.

A Bloomberg article discussed the on-going investigation into the manipulation of the Libor rate and the regulatory effort to overhaul how Libor is set.

U.K. regulators and banks met to discuss revisions to the setting of global interest rates after lenders faced allegations that they manipulated the benchmark for about $360 trillion of securities. 
The meeting was held yesterday to “consider future regulatory and market developments” for the London interbank offered rate, the British Bankers’ Association said in a statement today. 
Regulators and banks now plan to initiate a “technical discussion” about “likely future developments” with market participants who rely on Libor, the BBA said. 
U.K., U.S., Canadian and Japanese regulators have been investigating whether banks misstated Libor submissions to hide their difficulty raising funds or to benefit trading positions in interest rate derivatives tied to the benchmark. 
The probes have called into question whether lenders can be trusted to set, with no regulatory oversight, a rate that is linked to everything from floating-rate mortgages to commercial loans.
Who would possibly think that it is a good idea to "trust" lenders to set this rate in a completely opaque process?
Libor is generated through a daily survey of firms conducted on behalf of the BBA in which banks are asked how much it would cost them to borrow from one another for 15 different time periods, from overnight to one year, in currencies including dollars, euro, yen, and Swiss francs. After a predetermined number of quotes are excluded, those left are averaged and published for each currency before noon. 

1 comment:

Jake Cantrell said...

Mr. Field, your piece above about LIBOR manipulation was a thorough and relevant explaining the situation quite well. Similarly, I thought that you and / or your readers would find the Wall Street community's opinion as well as other related topics of interest: http://www.wallstreetoasis.com/forums/libor-manipulation-scandal-ignored-by-media Our community consists of a myriad of investment banking-oriented users so feel free to use it as a follow up if you like or as an expansion of traffic and ideas. I hope all is well and keep up the great work!