Wednesday, March 6, 2013

Regulating financial benchmarks: creating the right balance

A Bloomberg blog discussed creating the right balance in regulating financial benchmarks.

Regular readers are probably surprised to learn that there is any debate on this topic.  As your humble blogger suggested in the immediate aftermath of the Libor manipulation coming to light, the solution is to require the banks to provide ultra transparency.

Requiring banks to disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details achieves a number of import outcomes.

First, it unfreezes and keeps unfrozen the unsecured interbank lending market.  It does this because banks with deposits to lend now have access to the information they need to assess the risk and solvency of banks looking to borrow.

Second, it makes actual transactions the basis for all benchmark interest rates.  Market participants can use all or some subset of the transactions reported by the banks as the basis for constructing the benchmark interest rates.

Ultra transparency is such a simple, effective solution that it is surprising there is any debate on finding the right balance in regulating financial benchmarks.

Financial benchmarks determine payments on and set prices for at least $750 trillion worth of financial products, including mortgages, student loans, and credit derivatives. 
Achieving the appropriate balance to regulate financial benchmarks is crucial, as it will have a significant impact on the markets globally. It’s vital that they are developed with a strong, consistent, and transparent design that creates a level playing field for all. 
There are three key areas that we feel should be addressed: (1) Creating non-discriminatory access; (2) Avoiding monopolies via exclusive licenses; and (3) Ensuring that constituent and weighting information is available to all key participants....
Ultra transparency addresses all three of these areas. 
Finally, we are disappointed by one aspect of the framework proposed by Martin Wheatley of the UK’s Financial Services Authority which permitted access to individual Libor constituent bank contributions to be publicly delayed three months. This would represent a major step backward in transparency.
Regular readers are aware that the Wheatley Review refused to publish your humble blogger's suggestion of using ultra transparency to solve the problem with benchmark interest rates.
Benchmarks do not exist in a vacuum. In transparent markets, there is more likely to be the raw materials necessary to provide a verifier or a deeper understanding of existing benchmarks. In non-transparent markets, that opportunity doesn’t exist.
Thank you Bloomberg for explaining why ultra transparency is needed as the basis for the benchmark interest rates and not some combination of complex rules and regulatory oversight.

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