Libor's New Manager Has Its Own Conflicts
The really big news in financial markets this morning was the U.K.'s decision to hand over administration of the London interbank offered rate to the parent of the New York Stock Exchange. The price tag: one pound. The conflicts of interest involved: countless.
The scandal-plagued benchmark sets the interest rates for mortgages, corporate loans and derivatives -- more than $300 trillion in contracts worldwide. It was mismanaged by the British Bankers' Association, on whose watch traders rigged Libor to make their positions more profitable. Barclays Plc, UBS AG and Royal Bank of Scotland Group Plc have been fined more than $2.5 billion by U.S. and U.K. regulators and more than a dozen other firms are under investigation worldwide.
As of January, Libor will be run by NYSE Euronext, the owner of the iconic stock exchange and a London-based futures exchange that happens to be a dominant player in interest-rate derivatives. A new owner was essential. But one that runs one derivatives exchange and is about to be subsumed by another, IntercontinentalExchange Inc.?
That strikes me as problematic. NYSE Euronext operates Liffe, Europe's second-largest derivatives exchange. Its interest-rate futures and other derivative instruments, some of which use Libor and related benchmarks as a component, are among the most heavily traded in the world.
Handing off the benchmark to owners whose profitability depends on Libor's continued credibility isn't necessarily a bad idea. But it does give Libor's new owner a billion reasons not to upset the status quo, and the status quo isn't right.
The rate is now calculated by a poll carried out daily by Thomson Reuters Corp. for the British bankers' group. It asks institutions to estimate how much it would cost to borrow from each other for different periods and in different currencies. The top and bottom quartiles of quotes are excluded, and those left are averaged and published for individual currencies before noon in London.
The system depended heavily on self-reported estimates from banks that had huge incentives to manipulate rates. For now, the new owners plan to keep this system, with some additional safeguards, including subjecting banks' rate reporters to internal compliance rules.
What is needed, though, is a whole new way of calculating Libor. As Bloomberg View has advocated, a more transparent system would have banks report actual borrowing transactions, against which the public could check the truthfulness of the banks' estimates. (Full disclosure: Bloomberg LP, parent of Bloomberg News, proposed a Libor alternative, while Thomson Reuters proposed taking it over. Both were rejected in favor of NYSE Euronext.)
Creating a new method would be costly, time-consuming and controversial. If you run derivatives exchanges that trade instruments that depend on the continuation of the existing method, your resistance to change will be enormous. And that's one reason why you shouldn't expect to see improvements to Libor anytime soon.
(Paula Dwyer is a member of the Bloomberg View editorial board. Follow her on Twitter.)