Behind the Curtains of the World’s Key Interest Rate Benchmark

Regulators across the world looking for new strategies to strengthen the Financial Benchmark regime is evidently clear by now. The Financial Stability Board (FSB) driven multi-rate approach, which relies on (i) Strengthening the existing benchmarks by underpinning them on transaction data and (ii) Developing alternative, nearly risk-free reference rates, seems to be the direction where the reforms are headed.

Supervisory bodies across major financial markets in America, Europe and Asia are in the process of finding alternative rates primarily due to the dwindling volume of transactions in the underlying market for major benchmarks such as LIBOR, EURIBOR, SONIA etc. Notable examples include Bank of England’s Sterling Risk-Free Reference rates, US Federal Reserve’s Alternative Reference Rate Committee (ARRC), National Working Group of Switzerland, and European Secured Benchmark Indices Joint Task Force.

Interestingly, in the case of existing benchmarks, the administrators and the contributors are accelerating the implementation of reform measures with renewed urgency. This includes an overhaul of the existing processes, governance structures, data and technology implementations across submission, calculation, determination and dissemination of these long-standing rates. This is especially true for arguably the most often used and popular interest rate benchmark - LIBOR. With the introduction of a transaction-based waterfall methodology for determination, LIBOR has set a clear precedence in the right way forward for other benchmarks.

It may be prudent at this juncture to step back and take stock of the nuances of current LIBOR submissions. LIBOR Rate is administered and published by ICE Benchmark Administration, every business day at 11:00 AM London time. The underlying data for the rate is based on submissions made by panel banks prior to this publication time. The submissions are then arranged from lowest to highest rate and the final rate is calculated as a trimmed mean of this. An in-depth analysis into this ICE LIBOR transparency data (submission data) for the first quarter (Jan-Mar) of 2016 provides us with key insights on the submission rate patterns and resultant trends of panel banks’ influence on the LIBOR curve. Associates in Capital Markets (ACAPM) has been publishing quarterly reports in this regard. The analysis is based on all the submissions made by twenty panel-banks across all the five currencies and seven tenors of the benchmark.

The analysis focuses on gaining insights to certain pertinent questions such as “Which banks consistently influenced the rate for the given quarter?” “What is the level of variance between submitted rate of the bank vs. the final LIBOR rate?” “How far are the rates submitted by the outlier banks from the final LIBOR rate?” “Why are the rates submitted by certain banks consistently outside the average threshold of other panel banks?” and the like.

In summary, the quarterly average variance between submitted rates and the final LIBOR rates varies across currencies and tenors indicating higher levels of activity in some versus the others. In addition, the submission rates of banks also vary across currencies and tenors. The complete report for Q1 2016 can be found here.

As indicated in the evolution strategy timelines for crucial benchmarks, 2016-2017 seems to be the period of transition - to a robust, transaction-based determination system. Panel banks have already begun or are in the midst of the said process of transition. The impact of such regulatory measures may be expected to materialize from the second half of 2016. In the light of this, it may be of great interest to analyze how the LIBOR submissions fare in the second half of 2016 when the panel banks wrap-up the implementation of the ICE-driven Waterfall Methodology.

The impending implementation of European Benchmark Regulation (EU BMR) and the effect of Brexit (read as Third Country Provisions from EU BMR and the position of major UK-based benchmarks) on the same, is another area to watch closely. Banks and Financial Institutions may need to be proactive in handling the resultant strategic and operational changes.

View the full report here “LIBOR Determination Insights - Panel Bank’s Influence on LIBOR Curve - Q1 2016”

Previous quarter reports can be found here.

Disclaimer: The views and opinions expressed herein are those of the author and do not represent the views and opinions of the Associates in Capital Markets (ACAPM) or any of its subsidiaries or affiliates or clients.