Morgan Stanley has called for the Bank of England to replace
the British Bankers Association (BBA) in running the
London Interbank Offered Rate (Libor) settings. But a less
transparent rate-setting methodology is required for the move
to be effective.
The BBA last month asked the UK government to consider
regulating and supervising the Libor setting process following
the imposition of a £290 million fine on Barclays amid
allegations of rate-fixing.
Historically the benchmark-setting process has been
considered a private activity run by the banking trade body,
although the banks who participate in the rate-setting process
are regulated by the Financial Services Authority (FSA).
Morgan Stanley research analyst, and co-author of the
banks recent Interest
Rate Strategy report, Elaine Lin told IFLR the BBA
had not done a good job so far and therefore no longer had the
market credibility to continue in their current role.
No one wants to rely on them and the valuation method
they use, she said. The Bank of England or another
regulator that has some resolution under the central bank or UK
government would be the best alternative.
Market participants support the move. It would likely
improve governance by leaving rate-setters less incentivised to
manipulate the measure. Nonetheless, they argue the move will
have very little impact unless different teeth are put into the
Certainly, Morgan Stanleys report states the
transparent methodology currently used by BBA to set rates is a
limitation. Every contributors rates are published
individually, and the maths of arriving at the fixing is
transparent, it said.
Lin agreed the UK central bank would need to modify the
valuation methodology and not disclose every single detail of
banks submissions to the market.
The transparent methodology currently used would have
deterred banks like Barclays from making real costs of funding
known to the market, she said.
Market participants also suggest amending the measure to be
a post-transaction rate, rather than a forward-looking
benchmark. This would remove the self-fulfilling element
of the rate, said one in-house counsel at a European
But one securitisation banker warned that if the Bank of
England agreed to assume responsibility for the setting of
Libor or whatever benchmark that may replace it, they would
have to consider the potential unintended consequences that
might arise from changing the rate setting process.
One unintended consequence might be a rate that is
significantly more volatile than Libor has historically been,
especially during financial crises such as the one in
2008-9, he said. If the rate continues to be based
on bank funding costs, you could see market rates affecting,
for example, mortgages, consumer loans and derivatives rising
rapidly at just the wrong time in the business cycle.
Their comments follow remarks made by the European
commissioner, Michel Barnier, this week that
industry groups could no longer be trusted by themselves to
set benchmark rates. And calls by the European law enforcement
commissioner, Viviane Reding, for European regulators to take
on a bigger role in overseeing benchmark measure, such as Libor
and its European equivalent Euribor.
The European Commission also
announced yesterday its plans to introduce EU-wide rules
criminalising interest rate fixing.
The move, which will see manipulating benchmark rates added
to insider dealing as criminal offences, aims to encourage
stronger public oversight of the financial industry's role in
setting these benchmarks.
Lin believed significant changes to the benchmark were
unlikely in the near-term, however. There are so many
legacy issues with Libor that any alternative proposed will
need to be very very close to the current measure, she
said. Major reform of the benchmark measure is a few
Alternatives suggested to-date include allowing truly free
markets to operate by, for example, conducting independent
sampling of a random selection of anonymised actual trades.
Lawyers in the UK have acknowledged this as a
Australias benchmark interest rate could also be
extended to Libor to improve its transparency, integrity and
avoid scope for manipulation.
When speaking with IFLR last week, Kelley Drye &
Warrens James M Keneally said focus was also needed on
improving the audit function over Libor reporting.
This 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 perfect sense.
There was logic too in fine-tuning the bid process, as well
as in making bids anonymous and specifying transaction sizes,
Morgan Stanley believes the standard International Swap and
Derivatives Association (ISDA) swap agreement will facilitate
whatever Libor reforms are eventually implemented.
While we have no legal expertise whatsoever, it
appears to us that the wording of the standard Isda swap
agreement is surprisingly unthreatening to a change in the
methodology of the Libor fixing, as it refers to a page source
(in the first instance) rather than to a definition of Libor
itself, the report stated.
Certainly, a change in the calculation of Libor would
not be unprecedented (e.g., the change in the panel bank
question in 1998), it added.
When contacted by IFLR, a Bank of England press
officer said they were awaiting the conclusion of the
investigation into the Libor-setting process by the UKs
FSA before commenting.
An ISDA spokesperson declined to comment on the matter.