Libor's dominance should be no protection from change
Market conditions should be set by tangible data points. Pricing trillions of dollars of financial products based on the estimates of a small elite of submitters, however tightly regulated these days, is no longer tenable, and a change is due.
Much of the anger that western electorates feel these days is provoked by the appearance of an insiders’ club in their societies’ professional classes, be this Washington, Westminster, the City, or, um, professional journalistic punditry. Even if the elites that occupy these positions are not outright corrupt, much of the public believes they are changing the rules of the game to suit themselves.
The Libor scandals fit the bill and fuel these anxieties in the public imagination. A chummy group of millionaire bankers manipulated a benchmark that was opaque to much of the public, yet, they quickly found, underpinned everything from their local council spending to their mortgage rate.
The tirades of trader slang, obscenities, and some distinctly unsympathetic public appearances firmed up the impression of an out-of-touch group taking ordinary people for fools, and exploiting even their own employers for corrupt profit. That the main losers from Libor manipulation were other Libor traders, and that many of the perpetrators have now been cleared of wrongdoing matters not a jot to the public perception of the issues. Rehabilitating the City means impressions also matter.
More vigilant regulation goes some way to help, but it remains open to criticism while the rate is calculated by submission, rather than by real market transactions, robust enough to withstand manipulation. As long as Libor’s calculation remains a mystery, even to some market participants, its credibility will rightly remain in question.
As fintech and big data surge through the City, the capacity and the funds for change exist. Given the amount of information banks are able to crunch and their pride in innovation there is simply no excuse for the underlying on trillions of dollars of derivatives contracts to be based on narrow human estimates and not solid data points.
Any transition to a new reference rate will undoubtedly be arduous and frustrating. But that does not make it less necessary. As has cannily been pointed out, Libor is the rate at which banks do not lend to each other and that makes it hard to justify as a robust global benchmark.
In the short term, finance can avoid having to answer questions about such arrangements because most people do not understand them.
But when those questions are asked again, in front of committees, politicians will make hay with the way that Libor is calculated.