Libor Scandal Seen Boosting NYSE Repo Futures

Barclays Plc Former CEO Diamond
Robert "Bob" Diamond, former chief executive officer of Barclays Plc. Photographer: Paul Thomas/Bloomberg

The scandal impairing confidence in the London interbank offered rate, a benchmark for $360 trillion in securities, may drive demand for interest-rate futures that NYSE Liffe U.S. will start offering this month.

The contracts on NYSE’s U.S. futures exchange will be tied to indexes that track movements in a $400 billion market where bond dealers that trade directly with the Federal Reserve finance securities holdings. The futures were developed to give banks a more direct method of hedging changes in the cost of those transactions, known as general collateral finance repurchase agreements, or GCF repos.

Bankers and investors are debating whether alternatives to Libor exist as confidence in the benchmark diminishes following Barclays Plc’s admission that it submitted false rates. Robert Diamond, who resigned as Barclays’s chief executive officer after the bank was fined 290 million pounds ($451.4 million), told British lawmakers last week that other banks lowballed their Libor submissions.

“Something like the GCF rate makes some sense to a lot of people because it is a prolific market, there are trillions of dollars in repo trades outstanding, and a lot of people use it,” Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, said in a telephone interview. “The futures have a pretty good chance” of succeeding, he said.

Rate Swings

The average rate for borrowing and lending Treasuries for one day in the repo market was 0.224 percent on July 6, according to the Depository Trust & Clearing Corp.’s GCF Repo index for Treasuries, one of the measures that futures from the NYSE Euronext unit will be tied to. The index is a weighted average of all so-called general collateral finance repurchase agreements between dealers each day through the tri-party market.

Three-month dollar Libor, published daily by the British Bankers’ Association, was set at 0.4576 percent on July 6.

“GCF repo is basically everything that Libor is not,” Tom Callahan, chief executive officer at NYSE Liffe U.S., said in a June 28 telephone interview. “It’s a very deep, very liquid market, based on real trades, fully collateralized and centrally cleared. That has started to look like a very appealing alternative to Libor.”

Community Health

Elsewhere in credit markets, Community Health Systems Inc., the second-largest U.S. hospital chain, plans to raise $1 billion to refinance notes maturing in 2015. Videocon Industries Ltd., controlled by billionaire Venugopal Dhoot, was said to plan to borrow as much as $1.4 billion to develop energy assets in Mozambique. Benchmark gauges of corporate credit risk in the U.S. and Europe rose.

Proceeds from Community Health’s new senior debentures due in 2020 will be used to purchase its 8.875 percent bonds at 102.6 cents on the dollar after a July 3 tender offer, the Franklin, Tennessee-based company said today in a regulatory filing.

Community Health Systems is selling the debt less than two weeks after the U.S. Supreme Court decided to leave President Barack Obama’s transformation of the health system substantially intact. Junk bonds of health-care providers rallied after the ruling, which boosted investor optimism for the industry by reducing the risk that the companies will be stuck with unpaid bills.

Videocon Loan

IDBI Bank Ltd. and SBI Capital Markets Ltd. are arranging the loan for Videocon, according to a person familiar with the matter who asked not to be identified because the information is private. The two arrangers are marketing the debt to other lenders, the person said.

Videocon, based in the western Indian city of Aurangabad, The Woodlands, Texas-based Anadarko Petroleum Corp. and Indian state refiner Bharat Petroleum Corp. operate 10,500 square kilometers (2.6 million acres) of offshore gas fields in Mozambique. The fields, called Offshore Area 1 of the deepwater Rovuma Basin, hold at least 10 trillion cubic feet of gas, more than the proven reserve of the U.K., Anadarko said in a statement on Oct. 5.

Bonds of Fairfield, Connecticut-based General Electric Co. were the most actively traded dollar-denominated corporate securities by dealers today, with 32 trades of $1 million or more as of 11:54 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Credit Swaps

The Markit CDX North America Investment-Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, rose 1.1 basis points to a mid-price of 113.7 basis points as of 11:48 a.m. in New York, according to prices compiled by Bloomberg. The index climbed for a third day after reaching an almost two-month low of 106.5 on July 3.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings increased 0.7 to 172.5.

The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Incremental swings in short-term interest rates have grown in importance as the Fed holds its target near zero for a fourth year to support the economy.

Incremental Leverage

In a repurchase, or repo, agreement, U.S. government securities are exchanged for cash, with the debt held as collateral for the loan. Dealers, who use the transactions to finance holdings and increase leverage, agree to repurchase the securities at a later date and cash is sent back to the lender.

In a general collateral repo transaction, the lender of funds is willing to accept a variety of Treasury, MBS or agency collateral.

GCF repo, a fraction of the $5.5 trillion repo market, was introduced in 1998 by DTCC’s Fixed Income Clearing Corp. unit with JPMorgan and Bank of New York Mellon, the clearing banks that function as the agent and collateral holder in tri-party repo transactions.

New York-based DTCC, which processes more than $3 trillion in repos each day, publishes a repo index for Treasuries, agencies and agency mortgage-backed securities.

Lost Credibility

Libor is derived from a survey of London banks conducted each day by Thomson Reuters Corp. on behalf of the BBA. Bloomberg LP, the parent of Bloomberg News, competes with Thomson Reuters in selling financial and legal information and trading systems.

Lenders are asked how much it would cost them to borrow from each other for time periods from overnight to one year in different currencies. After a set number of quotes are excluded, those remaining are averaged and published for each currency by the BBA before noon.

“Libor has lost a lot of credibility,” said Tim Price, a money manager who helps oversee more than $1.5 billion at PFP Group LLP, an asset-management firm in London. “So far, Barclays has been first out of the trap. It seems almost certain there will be more names to follow.”

A viable new benchmark index would take a survey of rates from actual money-market transactions anonymously, with repo rates among the possible measures, Price said.

Libor Alternatives

“As people look for alternatives to Libor, the question is whether it should be a market rate or a non-market rate or a survey,” said Credit Suisse’s Jersey.

The Treasury Borrowing Advisory Committee, the bond dealers and investors who meet quarterly with the government, included the DTCC GCF Treasury Repo index among choices for a benchmark money-market reference rate for a floating-rate note program they proposed.

Fidelity Investments, the largest manager of money-market mutual funds, recommend the notes be linked to the GCF Treasury repo index, according to a letter issued during a public comment period. A derivative market based off the repo index would enhance the attractiveness of the index as a reference rate, Boston-based Fidelity said in the note.

New York-based NYSE Liffe U.S. will begin trading repo futures based on three DTCC indexes on July 16, listing the 30-day contracts for 24 consecutive months.

Trading in the market may reach 500,000 contracts a day, Citigroup Inc. analysts Neela Gollapudi and Timothy Chung wrote in a July 6 note to clients. “We would not be surprised if it takes several quarters to several years” to get to that level, they said.

Volatile Rates

“While hedging short rates might not be a large concern when the Fed is on hold, repo rates have been surprisingly volatile for the past several years, sometimes more so than Fed Funds or Libor,” they wrote. Dealers and investors that seek to protect against those fluctuations by buying futures on other benchmarks face the risk that the two won’t move in tandem, they said. “These market participants would normally prefer to hedge repo risk with repo futures,” the analysts wrote.

Even the most well-planned futures contract can struggle to generate enough demand to succeed, such as oil futures on Middle Eastern crude that attracted little attention from investors, said Ed Ditmire, an analyst at Macquarie Group Ltd.

“A lot of seemingly thoughtful contracts don’t succeed,” he said in a telephone interview.

Deriving the GCF rate from actual repo trades, as compared to Libor, which is set by bank estimates of how much it would cost to borrow from one another, “will be a good selling point” for NYSE, Ditmire said.

CME’s Eurodollar

CME Group Inc., the world’s largest futures exchange owner, still has the most-popular interest-rate future in the Eurodollar, even as trading volume in the first quarter fell 19.2 percent from a year earlier, according to statistics compiled by the Futures Industry Association, an industry trade and lobbying group. The contract tracks interest-rate movements over three months and settles against the BBA rate.

About 126.3 million Eurodollars changed hands in the first three months of 2012, compared with 156.2 million in the same period last year, according to the FIA data.

Trading in CME’s contract on the Fed’s overnight rate has fallen 48 percent in the first half of the year compared with last year, to an average 57,892 trades a day from 111,279 per day, according to Michael Shore, a CME spokesman.

The Libor price-fixing scandal may help NYSE tap demand for an alternative, Ditmire said. “It’s a very interesting and opportunistic time to be thrusting themselves into this with an innovative product.”

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