Counterparties: How to fix libor
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The Wheatley Review is out. No, that’s not an obscure literary magazine – it’s a British regulator’s proposal to overhaul Libor, everyone’s favorite manipulated benchmark interest rate. In June, Barclays agreed to pay a $470 million fine for manipulating Libor.
Libor is calculated daily based on banks’ own reporting of their borrowing costs, which, of course, left it open for manipulation. If banks report high borrowing costs, the markets can get spooked and think they’re in trouble; report artificially low borrowing costs, like Barclays did, and your traders could make millions.
Enter Martin Wheatley, who’s the managing director of the UK’s Financial Services Authority and wants to push “the reset button on Libor”. The new Libor will no longer be overseen by the inherently conflicted British Bankers’ Association. Say goodbye, in other words, to that secret Libor committee of bankers meeting in undisclosed locations. Manipulating Libor will now also be a criminal offense, and Libor will be simplified to 20 rates from 150. Also, Libor will be more closely tied to real lending transactions whenever possible.
All of this seems perfectly sensible and drew praise from Bloomberg and Breakingviews’ George Hay. Simone Foxman likes the proposal because it restores Libor to its original state of a “high-brow measure of interbank lending”. To Matt Levine, who’s done terrific work on the subject, the guidelines for what counts as a real transaction are vague enough that it’s still a matter of “ehhh, figure out the right Libor and write it down.” But Wheatley does get the incentives right:
The Wheatley Review doesn’t blow up the $300 trillion of contracts referencing Libor; it just gently nudges banks away from them. Now they know that judgment-based Libors will be subject to a lot of scrutiny and criminal penalties, so they have every incentive to come up with a better system that avoids jail risk for them – but that also is efficient and trustworthy enough for the market to adopt.
In theory, that would prevent traders from chuckling over instant messages like “Nice libor“. — Ryan McCarthy
And on to today’s links:
BofA just paid $2.43 billion to settle charges it hid losses at Merrill Lynch – DealBook
How BofA execs hid their losses – in their own words – ProPublica
BofA has paid $29 billion in settlement costs since 2009 – WSJ
Stuff We’re Not Linking To
The benefits of a more vigorously vibrating iPhone – Atlantic Wire