Unintended Consequences of FSA’s Martin Wheatley: Euro Credit
Borrowing costs for consumers and companies will rise as efforts to revive confidence in Libor increase the number of banks involved in setting the rates, which determine more than $300 trillion of securities.
A higher number of lenders will include smaller, weaker institutions that pay more to borrow, according to James Edsberg at Gulland Padfield, a London-based financial services consultancy. Euribor, the benchmark for interbank deposits in euros, is set by 43 banks and has been fixed higher than euro Libor, determined by 15 lenders, by an average 5.7 basis points since March 2009, according to data compiled by Bloomberg.
“If you expand the panel by including banks beyond the largest ones, you will boost borrowing costs,” said Edsberg.
Proposals for reforming the London interbank offered rate were set out by Martin Wheatley, managing director of Britain’s Financial Services Authority, last week as regulators probe attempts to manipulate the benchmark by at least a dozen banks around the world. The review was ordered by George Osborne, the U.K. Chancellor of the Exchequer, after Barclays Plc (BARC) was fined a record 290 million pounds ($470 million) for attempting to rig the rate.
As part of the revamp the FSA will encourage more banks to submit quotes and will have powers to force the unwilling to take part in the process, Wheatley said in his report. The banks that will make up the pool will be selected by the new administrator, said Chris Hamilton, a spokesman for the FSA, who declined to comment further.
Rising borrowing costs risk deepening Europe’s debt crisis, making it harder for countries in the grips of austerity to foster economic growth. In Spain, where Prime Minister Mariano’s government announced its fifth budget-cutting package last week, economists expect a contraction of 1.3 percent next year, according to the median of 21 forecasts in a Bloomberg survey.
Pessimism about the ability of euro-area leaders to resolve the crisis sent Spain’s 10-year yields to a three-week high of 6.11 percent on Sept. 28 and they are at 5.86 percent today. Italy’s 10-year borrowing cost is 5.07 percent, up from 4.92 percent on Sept. 19.
The Libor benchmark is calculated by a poll carried out daily by Thomson Reuters Corp. on behalf of the British Bankers Association, a banking industry lobby group, that asks firms to estimate how much it would cost to borrow from each other for different periods and in different currencies. The top four and bottom four quotes are excluded, and those left are averaged and published for individual currencies.
The panel setting Euribor, under the aegis of the European Banking Federation, includes National Bank of Greece (TELL) SA in Athens, which is awaiting recapitalization, and Bank of Ireland Plc, that country’s biggest lender. There are also four Italian lenders, including Intesa Sanpaolo SpA (ISP) and UniCredit SpA (UCG), the two largest, and four Spanish banks including Banco Bilbao Vizcaya Argentaria SA (BBVA) and Banco Santander SA (SAN), also the two biggest.
The panel for the BBA’s euro Libor includes Santander unit Abbey National Plc as the only lender connected to the peripheral countries.
“On day one of the new rate being introduced it will jump higher if you increase the number of participating banks beyond the biggest ones that currently set it,” said Ian Gordon, a London-based analyst at Investec Plc. (INVP) “That obviously raises questions about the viability of the contracts that reference the old rate. It would seem to be a fundamental flaw in the new proposals.”
Wheatley’s proposals include dropping fixings for more than 100 rates where trading data isn’t sufficient and introducing a code of conduct backed by criminal penalties. Rate-setters will be regulated by the FSA, and the day-to-day running of the rate will be put out to tender.
“If you expand the panel to include a set of smaller banks, all else being equal that would tend to push up the average rate,” said Steve Hussey, a London-based financial- institutions analyst at AllianceBernstein Ltd., which oversees about $400 billion. “You could weight it by size or rating but that would be complex and may not be effective.”
Wheatley proposes allowing banks to wait three months before disclosing their Libor submissions, rather than publish them daily as at present. While immediate publication of individual submissions increases transparency, it makes manipulation easier because contributors are able to estimate the impact of the quote they put in.
Added to that, at times of stress, changes in submissions may be viewed as reflecting the contributor’s credit strength, offering an incentive to submit a lower rate than otherwise, according to the report. To rectify the “reduction in immediate transparency” the report recommends lenders publish a regular bulletin that includes trading volumes.
“A three-month wait and then we find out that some of these institutions are more wobbly that we thought,” said James Ferguson, chief strategist at Westhouse Securities Ltd. in London. “That’s a horrible legacy for us to leave for the next crisis.”
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