Libor, Mifid and risk margins

The week on Risk.net, August 11–17, 2017

REPLACING LIBOR: weary US swaps market eyes long to-do list

MIFID swaps transparency splits regulators

INSURERS question BoE warning on risk margin

 

COMMENTARY: The cost of complacency

Almost 10 years ago, in January 2008, Risk.net was the first media outlet to raise suspicions that the Libor benchmark was being systematically rigged for private gain. The benchmark is now on its way out, but ditching Libor is unlikely to be a rapid or easy task. Trillions of dollars’ worth of contracts will need to be amended to refer to other rates, as the Libor benchmark will no longer be supported by the UK Financial Conduct Authority (FCA) after 2021.

The FCA said last month that banks had agreed to continue contributing to Libor fixes until the end of 2021, but users of the similarly beleaguered Euribor benchmark are still waiting for the same assurance from its supervisor, the Belgian Financial Services and Markets Authority (FSMA). The FCA managed to get a voluntary commitment from the Libor panel banks. The FSMA will be hoping for the same – the alternative is to compel them to participate, but that buys the markets only two years of Euribor fixings, which may not be enough. A voluntary commitment will not be easy to obtain; 29 members of the 49-strong panel have stopped contributing since the Libor-rigging scandal broke, fearing legal and reputational risks.

Libor was doomed by a trio of factors: rigging for individual and corporate gain; low-balling of submissions during the crisis to give a false impression of financial strength; and the post-crisis shrinking of the unsecured interbank lending market. The third development means that, even if every bank involved had behaved with complete honesty throughout, we would still now need to replace Libor. Banks would have genuine difficulties submitting accurate and reasonable unsecured borrowing rates if they were not, in fact, regularly active in the unsecured market; and, in any case, Libor loses much of its relevance as a benchmark once banks stop obtaining significant funding through the unsecured market. The first prediction that Libor was on the way out as a benchmark came in early 2009.

But the environment – in this hypothetical situation of honest banks just moving away from unsecured borrowing – would be far friendlier. Without the stream of fines and lawsuits over Libor, submitters would be co-operative rather than running for cover. The transition would be a voluntary one, conducted under much less time pressure, and there would presumably be no need for the threat of compulsion to keep submitters involved. Banks would doubtless also find that abandoning Libor at their own pace would be cheaper and involve less operational risk.

Libor-rigging may have boosted the numbers for a few desks – or even for a few banks overall, though it is hard to calculate its impact at institution level. It is unlikely but possible that lowballing their submissions during the crisis may have helped some banks survive by giving the world a falsely optimistic view of their ability to obtain funds.

But set against that are the billions in fines and settlements paid by the banks after their behaviour was discovered, and the huge impending costs and risks of the hurried abandonment of Libor as a benchmark. The price of the poor controls and short-termist culture, which allowed the Libor scandal to happen, could not be clearer.

 

STAT OF THE WEEK

Barclays reduced its derivatives assets by £87 billion ($113 billion) in the first six months of the year due in part to treating variation margin as the settlement of a cleared derivative, rather than as collateral. 

 

QUOTE OF THE WEEK

“Qualitative CCAR standards are now the de facto standard of enforcement. For a long time, it was possible to run your US operations on the back of a cigarette packet. The Fed has put foreign banking organisations on notice that there is a minimum standard of back-office systems and compliance capabilities. They aren’t tolerating the level of extreme sloppiness that used to be tolerated pre-CCAR” – Dan Davies, Frontline Analysts

 

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