Regular readers know that your humble blogger has recommended as the permanent solution for fixing the problems with the Libor interest rates that banks be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.
This disclosure is needed so that banks with deposits to lend can assess the risk of the banks looking to borrow. This unfreezes and keeps unfrozen the interbank lending market.
This disclosure is needed so that the Libor interest rates can be based off of all or a subset of the actual trades.
I have recommended that this disclosure be collected, standardized (including stripping off borrower privacy protected information) and disseminated by a data warehouse. The day to day operation of the data warehouse should be run by a global information technology firm with no conflicts of interest in the dissemination of the data.
Overseeing the global information technology firm and coordinating all aspects of the data warehouse is a firm with the subject matter expertise. This firm must have no conflicts of interests including any ownership by the banks. This firm's sole business should be making sure the data warehouse provides reliable information.
From the Bloomberg editors,
Sooner or later, the global inquiry into the rigging of Libor will have to deal with a sticky issue: what to do with the British Bankers’ Association, the trade group that was supposed to guarantee the integrity of one of the world’s most important financial benchmarks.
Founded in 1919, the BBA exists primarily to lobby for the interests of its member banks....
If the BBA had set out to design a system that its members could manipulate, it couldn’t have done a much better job. Instead of using the interest rates from actual transactions, the association relies on banks to report their borrowing costs. The chairmen of the committees that are supposed to oversee Libor, investigate misbehavior and impose sanctions are all from contributing institutions. Absurdly, the BBA won’t say whether the committees have ever taken any enforcement actions, and keeps secret the names of all the committee members. That amounts to letting the banks act as police, judge and jury in a Star Chamber.
We now know that bankers exploited Libor’s flaws as early as the 1990s. They manipulated their numbers to improve traders’ profits and to hide their financial troubles.
All the while, the BBA demonstrated its utter inability -- or unwillingness -- to stop it. There is even evidence suggesting the BBA was complicit.
Consider, for example, a conversation between a senior Barclays Plc manager and a BBA representative cited in the bank’s settlement with the U.S. Commodity Futures Trading Commission.
In April 2008, when a Wall Street Journal article questioned the integrity of Libor, the manager “informed BBA in a telephone call that it had not been reporting accurately, although he noted that Barclays was not the worst offender of the panel bank members. ‘We’re clean, but we’re dirty-clean, rather than clean-clean.’ The BBA representative responded, ‘no one’s clean-clean.’”
The BBA’s response has been a case study in self-regulation gone wrong. Throughout the period of manipulation, the BBA consistently claimed that Libor was reliable....The primary reason that self-regulation goes wrong is opacity. In the case of setting the Libor interest rate, without disclosure of the actual trades, banks were free to engage in misbehavior and manipulate the rate.
Given the BBA’s history and inherent conflicts, it’s hard to imagine how it could be found fit and proper to manage Libor. This is a big problem, because the association owns the Libor trademark. Hundreds of trillions of dollars in financial contracts cite BBA Libor.In order to restore trust in Libor, besides requiring the banks to provide ultra transparency, it is critical to eliminate, where possible, all conflicts of interest in the operation and management of the data warehouse.
That is why I stressed the need for the firm coordinating all aspects of the data warehouse and overseeing the information technology firm running the database to be free of all conflicts of interest.
Introducing conflicts of interest creates doubt about the trustworthiness of the data for no benefit.
Even if the market moves to a different benchmark, as Bloomberg View has advocated, those legacy contracts will be around for decades.
What to do?....Have the data warehouse license the BBA Libor trademark for 1 pound per year.
One option is to bring the currently unregulated Libor process under the purview of U.K. financial authorities. Regulators could sit on the Libor oversight committees and set enforceable rules for contributing banks. They could also mandate more transparency by requiring contributors to publish information on actual borrowing transactions, against which a bank’s Libor quotes could be checked.As per the recommendation of your humble blogger.
Ideally, the BBA should be removed from the picture. U.K. regulators persuaded Barclays Chief Executive Officer Robert Diamond to step down; they should put similar pressure on the BBA to sell Libor.
An organization such as a financial exchange or financial information company would have an incentive to guarantee the benchmark’s accuracy. (Disclosure: Bloomberg LP, the parent of Bloomberg News, has proposed its own alternative to Libor, and is a competitor of Thomson Reuters Corp., which conducts Libor surveys on behalf of the BBA.)No reason to use an existing market competitor with a conflict of interest to operate and manage this database. This creates an un-level competitive playing field for no advantage.
Rather, use the conflict of interest free coordinator and global information technology firm as I suggested.