Fri Sep 28, 2012 4:00pm EDT
(Corrects name in seventh graph)
By Karen Brettell
(Reuters) – Libor reforms announced on
Friday are seen as unlikely to cause large market shifts in the
near term, though some see changes as likely to add some
volatility in short-term bank funding, and push borrowing rates
at least marginally higher.
Some market participants also remain concerned about
conflicts of interest at banks that contribute the rate and also
run large interest rate swap books, despite assurances of
greater regulatory oversight, as the benchmark will continue to
be determined via a poll of funding costs.
Britain’s Financial Service Authority (FSA) delivered a
10-point plan to fix the benchmark, which underpins over $300
trillion contracts and loans, but found that rate is too
entrenched to replace, and struggled to identify alternative
market based measures that could be used as a substitute.
The rate has lost credibility on revelations that swaps
traders at large banks sought to manipulate the rate to benefit
trading positions, and after banks lowballed their borrowing
costs in the financial crisis in a bid to reduce fears over
their credit health.
An expansion of the panel of banks that submit rates to
Libor, a three-month blackout on the disclosure of individual
bank’s lending rates and a requirement to back submissions with
evidence of borrowing costs in other markets are among reforms
designed to reduce attempts to manipulate the rate.
It’s too early to know the effect on markets of the changes,
though much will depend on which banks are added to the panel.
“There is a lot of uncertainty over what the Libor panel
will look like in the future,” said Brian Smith, vice president
in rates trading at TCW in Los Angeles, which manages $130
billion in assets.
Many see few benefits for banks to contribute to the rate,
as regulatory and public scrutiny of the process increases.
Interdealer broker ICAP said in August that it would
discontinue a rate survey it had created as a substitute for
Libor, due to a decline in bank participation.
The European Banking Federation also launched a
dollar-Euribor index earlier this year, which is meant to
represent the cost of U.S.-dollar funding in the European
interbank market, and the panel included none of the 18 banks
that currently submit to dollar-based Libor.
Friday’s FSA report recommended legislation that would allow
the regulator to “compel” banks to submit rates if required.
MORE VOLATILITY, HIGHER COSTS
Adding more banks may push rates higher, if the panel
extends to lower-rated banks and those that borrow in the
short-term markets less frequently.
“In general I think more banks translates into a higher
benchmark rate because you included banks that aren’t as
efficient as borrowers in the wholesale markets and tend to pay
higher rates,” said Alex Roever, a money market analyst at
JPMorgan in New York.
The requirement to reference market borrowing rates when
making Libor submissions may also add to volatility in rates,
said Roever, noting that volatility in Barclays Libor
submissions picked up after the bank settled charges with U.S.
regulator the Commodity Futures Trading Commission in June.
The settlement included a requirement that the bank back up
its submissions by referencing other borrowing rates including
its commercial paper and certificates of deposits, and with
reference to markets including overnight index swaps, futures,
“The change increased the volatility of Barclays
submissions, at least temporarily, I think in part because they
are living more under a microscope,” said Roever.
FIGHTING OVER FRACTIONS
Some market participants, however, remain concerned that
swaps traders may continue to try to influence Libor settings,
as even minute changes can drive large gains or losses for banks
with interest rate derivatives positions based on the rate that
can be in the hundreds of billions of dollars.
As an example, take a bank that owes a trading partner
quarterly payments on a $50 billion portfolio of derivatives.
Here, a move as minute as one-tenth of a basis point in
three-month Libor, or one-thousandth of a percentage point, will
represent around $125,000. That means the bank will gain or lose
$1.25 million for each one-basis point change in the rate.
For some traders, the temptation to hold swap over the
setting may be too much.
“It may just create a better thief,” said one former swaps
trader at a bulge bracket bank.
In this respect, the precision of Libor settings is an
issue. Banks report rates out to five decimals of a percentage
point in Libor, while short-term lending in markets including
commercial paper more typically rounds out to three decimals of
a percentage point.
“The system delivers on a daily basis a very precise measure
of a market that actually doesn’t trade that much, or isn’t
observable, and is an opinion poll,” the trader said.
“It’s ripe for error, it’s a difficult task to perform
accurately on a daily basis because of the design,” he said.
(Reporting by Karen Brettell)