With the effects of the credit crunch and liquidity crisis in the money markets showing no signs of abating, the spotlight has turned to the role of the London Interbank Offered Rate (Libor) – the benchmark funding rate in the industry.
Complaints have been made that the Libor fixings, which are managed by the British Bankers’ Association (BVBA) do not reflect the rate at which money market traders are able to fund their books. Libor has come under criticism after suspicions mounted that panel member banks were misquoting the rates at which they would lend unsecured funds to other banks during the credit crunch.
As a result, three initiatives have been launched in the past month with two firms launching rival fixings and a survey by ACI – The Financial Markets Association seeking views of its members about the validity of the Libor fixings.
Inter-dealer broking firm Icap and exchange Euronext Liffe have both launched new products that could replace the Libor fixing.
Icap’s product is an American alternative called NYFR Fixings. It is a poll of one- and three-month unsecured bank funding costs conducted during the New York morning when the Eurodollar market is most active.
Doug Rhoten, CEO of Icap Americas, says: “The launch of our new NYFR Fixings index is the result of considerable feedback received from customers. There has been much discussion about measuring the interbank rate when market conditions are volatile and we believe that a survey conducted during the most active part of the US trading session will give us a concrete measure of actual funding costs.”
The survey is based on a market mid-rate, where banks submit a rate where another institution would be able to obtain funding rather than reporting its own rates.
Icap says it only publishes rates and not the names of individual bank contributors and the number of contributors in the NYFR Fixing index varies from day to day. A minimum of 16 participants each day is required in order to publish the rate. Icap may add other maturities to the program over time if there is market interest, it says.
At the same time, Euronext Liffe has thrown its hat in the ring with the launch of new one- and three-month Eonia (Euro Overnight Indexed Average) and Sonia (Sterling Overnight Indexed Average) index futures contracts.
The one-month contracts are referenced to Eonia rates, calculated each night by the European Central Bank, and published by Reuters. Similarly, the one month futures contracts on Sonia are referenced to Sonia rates, calculated and published each night by the Wholesale Markets Brokers’ Association (WMBA).
Euronext Liffe says that the one-month contracts have accrual periods in line with central bank reserve maintenance periods, providing a cost effective means of gaining or hedging exposure to overnight euro and sterling interest rates.
The product offers a centrally cleared, very near-term interest rate futures contract, which will free up capital for treasury, repo and reverse repo traders currently trading in the over-the-counter markets.
The three-month contract is referenced to the three-month Eonia Swap Index, sponsored by the European Banking Federation (FBE) and published by Reuters. The contract settles in line with IMM dates, offering a spread trading opportunity against the established and liquid three-month Euribor futures contract.
Garry Jones, executive director of business development and strategy at Liffe, says: “The current tight market conditions in both the euro and sterling short term money markets require us to offer a broader range of short term interest rate futures contracts, which are exchange-based with central counterparty clearing.
“We believe offering these products will be of real tangible benefit to the money markets, and will complement our existing three-month Euribor and Short Sterling futures contracts.”
Since then, the BBA has announced that it is revamping Libor by increasing the number of banks and adding a second survey during US business hours.
At the same time as the alternative fixings launched, ACI surveyed its members and received 106 responses to questions about the Libor fixings.
The first was: “It has been widely reported in the press that some Libor fixings have not reflected the actual prevailing money market rates for cash. Do you agree?”
A secondary question was asked: “Which fixings need to be improved and how can the quality of such fixings be improved?”
ACI reports that a majority 82% of respondents agreed (39%) or strongly agreed (43%) that the fixings were not reflecting actual market rates. Of these, 24% indicated that this mainly concerns the US dollar Libor fixing, which varies between 15 and 25bps from actual rates in the market. There were also mentions of off-market Swiss franc and sterling fixings. Indeed one respondent noted that Swiss franc fixings below actual market rates was a normal characteristic prior to August 2007.
Of the 18% that disagreed with the statement, three main points were promoted: that the Libor fixing is still the best reference of actual market rates that one can get; there has been a reassessment of credit risk and some have lost access to Libor borrowing; and it could well be true for other banks but this has not affected respondents’ funding.
In answer to the second question, the strongest opinion expressed was by 14% of respondents who argued that the number of panel banks participating in the fixing should be increased.
Others (6%) suggested that the fixing should be calculated as a weighted average of concluded trades throughout the day as is the case with the OIS fixings. An additional 5% asked for a new methodology that would change the definition of Libor from where institutions would be prepared to borrow to where they would be prepared to lend.
One respondent said: “Let the Treasurers set up the rate and not people out of the market, such as the loans department.”
Another said that Libor does not represent the interbank anymore as Treasurers use Eonia and the Fed Funds rate instead.
A third said: “Banks should contribute their rates without reference to rates contributed by other contributing banks, yet it is common knowledge that Libor fixings are predetermined by consultation with the brokers earlier in the day.”
Another comment was that the sponsors of the fixing (BBA and Euribor) should ensure that panel banks are aware of the rules for price discovery and contribute only rates which are in compliance with these rules. “Moreover, the sponsors should obtain informal rates from other banks to spot and investigate any differences to the actual quotes from the panel banks.”