Barclays' rate-fixing scandal has highlighted the widespread
inefficiencies within the London Interbank Offered Rate (Libor)
setting process. IFLR asked readers should Libor be scrapped?
Heres what they had to say.
|Should Libor be scrapped?
last month fined $453 million by the US Commodity
Futures and Trading Commission (CFTC) and the UKs
Financial Services Authority (FSA) for manipulating data, which
went into calculations of the Libor. The move has prompted
broader investigations into the Libor-setting process
within Barclays, and other global financial institutions as
well as the role regulators played in both identifying and
preventing the problem.
The key market index influences the costs of a wide range of
financial instruments. Indeed, it has been estimated that
$500tn of swaps use some form of Libor as a reference rate.
Historically, however, it has not been subject to any direct
regulation or sole supervision.
Bankers are searching for alternatives. But, when IFLR
polled lawyers from the UK, Europe and the US on whether the
Libor probe should mark the end for the benchmark measure, 81%
voted against the idea.
A US law firm partner said the idea made no sense. If
Boeing and Airbus were found to be colluding on jet aircraft
prices, would we abolish jet aircraft? he asked.
Its a major financial pricing benchmark; if you
scrap it, it leaves a crucial void.
CMS Cameron McKennas Daniel Winterfeldt said it was
important to remember that Libor has been used extensively and
successfully in the marketplace for some time.
Eliminating Libor would potentially create liquidity
issues and leave the market searching for a new benchmark
rate, he said.
Other respondents liked the elimination of Libor to
throwing the baby out with the bathwater.
Baker & McKenzie global head of banking, Bernard Sharp
said the idea might seem superficially attractive, now it had
been revealed not to be a perfect reflection of banks' true
cost of funds. But scrapping Libor would cause
chaos, he said.
There are probably hundreds of thousands of loan contracts
which have Libor-based interest rates, he explained. They all
provide back-ups if Libor ceases to exist; but the backups are
not the same. Many parties to such loans have hedged
their floating rate exposures by hedging, and the hedging won't
work if Libor ceases to exist, he said.
Abolishing Libor would alter contracts worth hundreds of
trillions of dollars. The resulting systemic and legal backlash
would be swift and expensive.
A minority of 19% of respondents believed Libor should be
abolished, however. One alternative suggested is to allow truly
free markets to operate by, for example, conducting independent
sampling of a random selection of anonymised actual
Lawyers in the UK have acknowledged this as a realistic
One UK-based law firm partner said that if actual sampling
of trades were to be used, it would require reporting of all
intra-bank lending to a central body. That may be
feasible," he said. "Indeed, it may have other benefits in
terms of accuracy of information for macro-economic
purposes, he said.
However, he stressed the central body would, for competition
law reasons, need to be genuinely independent and not a
There would be other issues to consider too, another
London-based partner said. For example, Libor currently
provides rates for a number of interest periods of different
lengths in different currencies - it may not always be possible
to get real time sampling of loans in those different
currencies - or, if it were, the samples might not be big
enough not to be distorted.
If Libor were to be replaced, Sharp believed it should only
be for new contracts, with the existing Libor system being run
in parallel, so that existing contracts weren't affected.
Finding a replacement would be a difficult but not
impossible task, with many possible sources, he said.
But other respondents questioned the efficacy of other
a trades-based benchmark to work, said one US lawyer, there has
to be substantial liquidity in the market being reported,
otherwise the reported trade information not only is less
reliable but is more subject to 'gaming' through adjusted price
trades and other gambits.
"It isn't Libor that needs to change, but bank practices and
the government regulation of those practices," he said.
Another poll participant questioned whether the Bank of
England should end its monopoly on fixing interest
rates. Sharp disagreed with the notion. "The Bank of
England only has a role to play in relation to Sterling (which
is but a small part of the Libor/Euribor market), and even that
is only on setting rates at which it will lend to banks
supervised by it, he said.
However, Winterfeldt believed that there was no doubt that
the system for setting Libor should at least be reformed.
This could include more stringent internal compliance
within participating banks and also through increasing the
number of banks contributing rates, he said.
While, Baker & McKenzies international capital
markets partner, Adam Farlow, said that other
self-certification systems also needed to be reconsidered.
There are two sides to every trade, and a review/spot
check of what counterparties are saying about offered rates for
the relevant banks would make a lot of sense, he
His comments follow
similar suggestions by the Bank of Englands Paul
Tucker to the Treasury Select Committee yesterday.