Tuesday, April 23, 2013

CFTC's Gary Gensler repeats call to base Libor on observable transactions

The CFTC's Gary Gensler keeps hammering home the point that the only way benchmark interest rates like Libor are both credible and not subject to manipulation is to base them on observable transactions.

Your humble blogger's question is when will regulators realize that the simple and only way to achieve this is to require the banks to provide ultra transparency and disclose on an on-going basis their current global asset, liability and off-balance sheet exposure details?

Ultra transparency both unfreezes and keeps unfrozen the unsecured interbank lending market.  It does this because it provides the banks with deposits to lend the information they need to assess the risk and solvency of the banks looking to borrow.

Ultra transparency also provides the data needed for calculating the benchmark interest rates.  Market participants can use all of the transactions in the unsecured interbank lending market or a subset of these transactions.

As reported by Reuters,

Two interest rate benchmarks that banks were fined for rigging should be scrapped and replaced by indicators based on market transactions, a top U.S. regulator said on Monday. 
The changes should also include benchmarks linked to gold, oil and other commodities, said Gary Gensler, chairman of the Commodity Futures Trading Commission said. 
Regulators from across the world are fleshing out changes to how two key interest rate benchmarks in particular, the London Interbank Offered Rate (Libor) and its continental European counterpart Euribor, are compiled.... 
"I believe Libor and Euribor are unsustainable in the long run. They threaten financial stability," Gensler said. 
Gensler co-chairs the group of regulators setting out principles on how benchmarks can be run and compiled to make them harder to manipulate....
What is so difficult about the principle that banks need to provide ultra transparency so the benchmarks can be based on actual transactions?
"The principles that we laid out are equally relevant to energy, metals, agriculture and financials - for any benchmark to be reliable and robust (it should) be anchored in observable transactions," Gensler later told reporters.
Users of contracts linked to all types of benchmarks should also have a "Plan B" if the transactions to compile them dry up, Gensler added.
Fortunately, with banks providing ultra transparency, transactions won't dry up as the banks with deposits to lend can continue to assess the risk and solvency of banks looking to borrow.

The interest rate paid by the borrowing bank might change, but that is what is suppose to happen in a functioning market.
He said Libor and Euribor fail to reflect wider market activity, noting how the cost of insuring one bank's bonds rose sharply during the Cyprus crisis while that bank's Libor submissions barely changed. 
"One might have thought the two would have had some relation to one another," Gensler said....
Transparency re-establishes this relationship.
The financial sector fears mayhem from a rapid switch to a new system for compiling benchmarks but Wheatley said changes would have to be phased in.
There should be absolutely no mayhem in the financial sector as ultra transparency is phased in.  Benchmark interest rates like Libor and Euribor will simply reflect the reality of what it costs the banks to borrow and not some bankers' bonus driven imagination of what it costs the banks to borrow.

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