Federal Reserve chairman yesterday branded the London Interbank
Offered Rate (Libor) setting process as
structurally flawed. But US and UK market participants have
warned equivalent indices must also be reformed if confidence
in the system is to be restored.
Bernanke is the latest to voice concerns over Libors
widespread inefficiencies following the $453 million penalty
imposed on Barclay last month by the US Commodity Futures and
Trading Commission (CFTC) and the UKs Financial Services
Authority (FSA) amid allegations of Libor manipulation. The
into the Libor-setting process within Barclays, and 16 other
global financial institutions.
market index influences the costs of a wide range of financial
instruments. It has been estimated that
$500 trillion of swaps use some
form of Libor as a reference rate. Historically,
however, it has not been subject to any direct regulation or
Baker & McKenzies global banking head Bernard Sharp
told IFLR that US criticism of the benchmark was
likely fuelled by a long-standing aversion to the US dollar
rate being determined offshore.
he agreed it was critical changes were made to the way banks
the Lehman crisis the interbank lending market shutdown to some
extent and as such the Libor became a hypothetical, guess-based
process, he said. The market needs to admit
its a guess, and base the rate-setting process on some
indices, such as the Euro Interbank Offered Rate (Euribor),
would also need equivalent reforms, he said, as these operated
in a similar fashion to Libor.
European investment bank securitisation head agreed. The
Libor probe raises questions about other indices, which are set
on the same principles and therefore susceptible to the same
level of manipulation, such as US Libor and Euribor, he
hard to say at this stage if its the reputation of the
Libor brand thats been damaged or just that of the
bankers who are believed to have manipulated it, he said.
Regardless, changes need to be made to an index that has
become far too prone to slippage.
of the banking community have largely concluded the index is
rubbish because of the rate-setting process itself, he
said. Traders are generally pretty dismissive of it
because its not based on actual trades and you therefore
cant put 100% confidence in the rate
as everybody in the market uses the same process you cant
distinguish yourself by not, as that would leave you outside
the market, he said.
believed choosing another factor upon which to base the rate
was going to be difficult, however.
of England base measure is set for macroeconomic, political
reasons and is therefore not a true reflection of the cost of
lending, Sharp said. However a rate based on derivative prices
or the cost of non-equity, non-subordinated securities would
not enable the same differentiation in maturities as Libor
option would be to implement provisions stipulated within the
Loan Market Association syndicated loan documentation in which
it states that if Libor does not reflect the cost of funding
for a certain percentage of banks, an alternative method of
setting interest rates can be implemented based on the
banks own cost of funds. But Sharp said competition
considerations would leave most banks uncomfortable with
revealing the real cost of funds. It would also leave
banks with a lot of hedging exposure, he said.
alternative base rate was chosen, he believed confidence in the
system would best be restored by instigating a system whereby
those giving quotes do so without undue influence.
should accumulate data in the same way as research analysts and
economists do in other areas of the bank, rather than operating
as a trader, said Sharp.
speaking with IFLR last week, CMS Cameron
McKennas Daniel Winterfeldt agreed reforms should include
more stringent internal compliance within participating
banks. Efforts should also be made to increase the number of
banks contributing rates, he said.
Drye & Warrens James M Keneally said focus was also
needed on improving the audit function over Libor
all ties back to the regulatory efforts in the US to impose on
corporations and financial institutions not just the duty to
monitor themselves but also the duty to self report, he
said. An audit function with regards to Libor makes
logic too in fine-tuning the bid process, as well as in making
bids anonymous and specifying transaction sizes, he
comments mirror reforms suggested by US Treasury Secretary
Timothy Geithner, when he was head of the New York Federal
Reserve Bank, in a 2008 private email to Bank of England
Governor Mervyn King which
the recommendations put forward by Geithner, in a
two-page memo dated May 27
2008, include strengthening and establishing a
credible reporting procedure, increasing the size and
broadening the composition of the US dollar panel, specifying
transaction size, and eliminating incentives to
Geithner's suggestions were generally good. But he was
concerned about the second fixing option from a practical
perspective. "Many transactions that use 3 month USD
LIBOR have it defined in the documents as the rate set at 11am
GMT, so all of these documents in the market would have to be
amended to gain any benefit from a second fixing," he
He believed Geithner's suggestion of a random sampling of rates
would be particularly effective in elminating the incentive to
The widespread inefficiences in the
Libor-setting process has prompted some bankers to searching
for alternative benchmark rates.
81% of IFLR readers last week voted to reform not replace