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The LIBOR rate-setting scandal has resulted in a massive increase in the cost of LIBOR to users and distributors of that rate. Given that $350 trillion of financial products have LIBOR as the underlying reference rate then that equates to a huge number of users. LIBOR is used as the rate-set for a vast array of financial instruments such as FRAs, interest rate swaps, interest rate options, loans and mortgages across a number of currencies (GBP, USD, CHF, EUR, JPY). Owners of such instruments need to know the LIBOR rate-set to determine cashflows.

LIBOR, or London Interbank Offered Rate, is set daily by the world’s largest banking institutions and was supposed to represent the rate at which these banks could borrow for pre-determined time periods. The manipulation of LIBOR first came to light with the onset of the global financial crisis in 2008 as the benign credit environment spectacularly imploded. The high levels of short-term debt held by institutions became incredibly expensive to fund, that’s if it could be funded at all. Banks became fearful of lending to each other as they did not have confidence that they would be repaid. During this period LIBOR was cynically dubbed “the rate at which banks don’t lend to each other”. The chart below shows the fear that gripped the interbank market at the height of the GFC when rates spiked to close to 7.00% for USD LIBOR.

USD LIBORThere were two main incentives for banks to manipulate LIBOR:

  • to give the impression banks’ balance sheets were healthier than they actually were
  • to profit from trading activities

Since the scandal first came to light there have been huge fines handed out to complicit banks, criminal investigations, as well as reforms in the administration of LIBOR. Since the mid-1980s until recently, the administration of LIBOR was carried out by the British Bankers’ Association (BBA). Earlier this year the administration of LIBOR was taken over by NYSE Euronext which is regulated by the UK’s Financial Conduct Authority. NYSE Euronext is now owned by the Intercontinental Exchange (ICE) Group.

As of 1 July 2014 the ICE Benchmark Administration is introducing a new commercial model for users and distributors of LIBOR. The fee depends on:

  • the timeliness of the data (live data is more expensive than delayed data)
  • who is using the data (financial institutions are charged more than non-financial institutions)
  • whether the data is being redistributed (such as via treasury systems).

From a rate-set perspective there has been a move away from LIBOR. In the 1990s there were 16 currencies that used LIBOR which dropped to 10 following the introduction of the Euro. There are now only five currencies. The most recently terminated currencies are the CAD, NZD and AUD with rate-setting now determined by CDOR, BKBM and BBSW respectively. Although these rate-sets are managed by various bodies, and come at a cost, at least the user, or redistributor, can pick and choose which rates/currencies to subscribe to. Unlike ICE which provides all five currencies whether you want them or not. Here’s hoping the additional regulation for these rate-sets eradicates corrupt practices. Unfortunately, as we have seen with the breaking of the forex rate-setting scandal there is plenty of other opportunities for greed and dishonesty.

Understandably increased administration costs, as well as the costs of (as it turns out much needed) regulation/policing, need to be recouped, however, the quantum of the fee increase seems excessive. As we have previously commented there is a clear trend for higher data costs and this is one of the challenges we at Hedgebook need to navigate to provide a simple and intuitive, but also low cost, treasury management solution.