LIBOR, EURIBOR & TIBOR: Taking Stock Half-A-Decade Later
It is not surprising that the ripples created by financial benchmark manipulations from a half-decade ago are felt even today in the form of convictions, appeals, fines and more importantly tighter regulations and oversight. The steps taken by regulatory bodies across geographies to restore the investor confidence is palpable with the emergence of distinct determination methodologies for major benchmark rates such as LIBOR, EURIBOR and TIBOR for instance. The impetus being, a decisive nudge from regulatory recommendations such as Wheatley Review, IOSCO principles, ESMA-EBA Principles and IBA Code of Conduct.
While banks and benchmark administrators have started to work upon these regulatory recommendations, it may be a good idea to take a stock of the progress so far; Especially in the light of the recent release of the review report of implementation of IOSCO’s principles for financial benchmarks by Administrators of EURIBOR, LIBOR and TIBOR.
In July 2013, IOSCO published a set of 19 principles for financial benchmarks considered as recommended practices to be implemented by administrators. These principles covered the four key areas of - Governance, Quality, Methodology and Accountability of the benchmark. Soon after, a review team was formed to understand the level of progress made by benchmark administrators in implementing the principles. In 2014, a first review was conducted as a desk-based exercise wherein the review team rated the implementation status of each of the 19 principles - derived out of responses from methodology based questionnaire.
In its second and latest review (published Feb 2016), the report intended to gauge the “direction of travel taken by administrators” since the first review. The following observations are made out of this.
Quality of Benchmark - It is clear from the review that there was considerable amount of work done by all the three administrators in the area of quality of benchmark specifically benchmark design and underlying data (principles 6 to 9). The engagement with relevant stakeholders and public consultations are a clear indication of this. A key point to note, however, is the emergence of common methodology theme across benchmarks based on active market information. This translates into benchmark determination predominantly based on observable, arms-length transactions in the funding market. Also, the methodologies for each of these benchmarks invoke a waterfall approach, albeit with their own flavour, which provide for events when reliable transaction information is unavailable or unrepresentative of the market.
However, the discussions are still ongoing and much depends on actual implementation of the said methodologies including transparency in the process of administering the benchmark rates. On the point of transparency, the procedures should, at a minimum, include the size and liquidity of the market being assessed and the pricing methodology used (transaction-based, interpolation, parallel shift etc.).
Governance - All the three administrators are rated as fully implemented or broadly implemented on the parameters of governance. With clear policies and procedural documentation active for overall responsibility, oversight of third parties, conflicts of interests, control framework and internal oversight, administrators are on track to achieve complete compliance on the said principles. Though, it is important to acknowledge the fact that this is an ongoing process where the governance practices must be reviewed and amended to best suit the prevailing investor sentiment.
Quality of Methodology - The implementation of principles relating to the quality of methodology appears to be fairly advanced for all the benchmark administrators with clear procedures and policies laid down for methodology, consultation procedures in case of material changes to methodology and submitter code of conduct. This is a welcome sign especially since the methodologies will undergo a major change within the coming 3-4 quarters and provides assurance that the administrators are well equipped to quickly disseminate the information without further delays.
Another area of importance for benchmark administrators is in relation to the contingency plan for transition to a fall back rate in case of the necessity for cessation of the benchmark due to a change in market structure, product definitions, or other such conditions which make the benchmark no longer representative of its intended interest. Currently, the administrators do not have any alternative rates though they have in place emergency measures to ensure continuous availability of rates (for e.g., using previous day’s LIBOR rate).
Accountability - Crucial to the entire benchmark determination and publication process is the ability of the administrator to demonstrate accountability through periodic and thorough audits, data audit trails, clear and reasonably swift complaint procedures and cooperation with regulatory authorities. Evident from the review is that the benchmark administrators are broadly compliant on these aspects. This ensures transparency across all the critical segments of the data collection, determination and publication of benchmarks. This also ensures that the credence of the benchmark is maintained.
In summary, the steps taken by regulatory authorities are poised to bear fruition in restoring benchmark credibility. The onus of which though, is shared equally between administrators and submitters. The question then arises ‘Will this suffice?’