The World’s Most Important Number

In 2009, as markets edged back from the abyss, London officials called LIBOR the most important number in the world. The BBA has controlled the rate setting process in 10 different currencies. The organization(and its lobbying affiliate) outsources the submission and posting job to Thomson Reuters. Last week, according to Bloomberg News (a competitor), the BBA deleted the links from its website that described its involvement with the rate setting process. Criminal investigations are expanding from a Canadian TIBOR (Yen) probe to the US Justice Dept.. On March 1 a lawsuit by Charles Schwab named multiple bank offenders including BofA and Credit Suisse as colluding to manipulate the set. Here's the money shot, LIBOR is the anchor for over $350 TRILLION in contracts and derivatives.

On March 5 the BBA, BOE, Treasury and FSA met to discuss the scam. In a statement the group said, "The intention is to develop LIBOR for a changing environment." Sounds easy, but what about the Yucca Mountain of existing agreements made in good faith against a fraudulent anchor? The BBA was keen to keep players calm saying, "We and the contributors intend to undertake the work in a manner that is conducive to market confidence." TOO LATE !

The faith based financial system that grew out of LIBOR's prominence  prior to 2008 no longer exists. Interbank rates, and thus their important spread relationship to risk free rates, are groping for a new equilibrium on their own. Anyone still evaluating the landscape in metrics reflective of the 1986-2009 LIBOR era is steering with a broken compass.

(For non-practitioners: the rate set is determined by the average of the submissions (dropping high and low outliers) for where a player "would offer" to another. An actual transaction is not required.)

2 thoughts on “The World’s Most Important Number

  1. Ivan

    It seems to me the most important words in this post are the last ones: “An actual transaction is not required.”

    In the world of equity derivatives, the largest contracts (index futures and options) are resolved based on prices that, themselves, are based on actual transactions. Final values for the S&P 500 contracts are derived from a trade value for each of the index’s 500 constituent stocks. Depending on the contract, those transactions are either the opening trade or the closing trade on the primary exchange on the relevant expiration date. Index arbitrage activity promotes lots of volume on expiration days. The point is that these cash-settled derivative contracts have a very tight price discovery process.

    So my instant reaction to this news flow on LIBOR fixing is a question: How did market participants get comfortable using derivative instruments that depend on an anchor price that is determined not by actual market prices, but by hypothetical transactions as articulated by entities which themselves may have an economic interest in the outcome?

    Moreover, what can regulators actually do to improve this mechanism going forward? It seems to me the “world’s most important number” should be determined by an open process, not a private club.

    Reply
  2. Mohit Sanganeria

    I think there is a mistake in the post…The rate banks post is what a bank expects to get a loan at and not at the rate it is willing to give…infact this has been a lacuna of the process…Please clarify

    Reply

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