IOSCO: Benchmark interest rates should be based on real trades

Led by the CFTC's Gary Gensler, IOSCO is calling for benchmark interest rates like Libor to be based on observable transactions.

Regular readers will recall that this is precisely what your humble blogger recommended.

And what should be the source for these observable transactions?

The source should be the banks through their disclosing on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Ultra transparency is needed for two reasons:

• It allows banks with deposits to lend or market participants looking to fund banks with the information they need to assess the risk and solvency of each bank looking to borrow.  This unfreezes and keeps unfrozen bank funding markets like the interbank lending market.

• It allows market participants to use all of the observable transactions or a subset of the transactions as the basis for the benchmark interest rates.  It allows market participants to use all of the banks or a subset of the banks as the panel for the benchmark interest rates and not worry about a change in composition of the panel.

As reported by Bloomberg,

Global regulators said interbank lending rates and other so-called market benchmarks should be based on data from actual trades in a bid to restore credibility of indexes tarnished by price-fixing scandals. 

A panel led by U.S. Commodity Futures Trading Commission Chairman Gary Gensler and U.K. Financial Conduct Authority Chief Executive Officer Martin Wheatley is also pushing for banks involved in benchmark setting to sign up to a code of conduct as part of a drive to make the process more robust. 

“To promote market integrity, it is critical that benchmark interest rates be anchored in observable transactions and supported by appropriate governance structures,” Gensler said in a statement on the International Organization of Securities Commissions’ website.....

Iosco, which brings together markets regulators for more than 100 nations to coordinate their rule-making, will seek industry feedback on the proposals through May 16, 2013. 

Benchmark setting is a process with “opportunities for abusive conduct,” through submission of “false and misleading data” or attempts to influence personnel charged with compiling data and publishing the rate, according to the Iosco report. 

The data used for rate-setting should be based on “observable transactions entered into at arm’s length between buyers and sellers,” according to the report, as the use of such “bona fide observable transactions” builds confidence, it said.