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Rigging Libor was wrong but so is tossing away the benchmark

Monopoly jail
By Tom Brown
30 Jul 2019

UBS and Citi trader Tom Hayes was jailed for 11 years for manipulating Libor. But while the trader argued that he was made a scapegoat for the financial crisis, perhaps the rate he rigged is a bigger victim.

Whatever the damage done by Libor rigging, it paled in comparison to the ills of the 2007-2008 financial crisis. The UK has to date not jailed anyone for their part in it.

Iceland, for comparison’s sake, sent 26 financiers to jail for combined sentences of 74 years after it defaulted in 2008. Spain imprisoned 11, and Ireland seven.

Those imprisoned in Iceland for the financial crisis argued too that they were scapegoats for the financial crisis. They have a point — the crisis brought a magnifying glass up to the wrongdoings of the financial sector, incurring public wrath and giving regulators the need to respond.

Like Hayes, the Icelandic bankers may argue that they were persecuted for a crime many others committed. This is true in the sense that the Libor scandal emerged as the meeting ground of public anger, government embarrassment, and a desire to correct the level of regulatory oversight.

Libor, however, had next to nothing to do with the mis-selling of securities. The Financial Times published an article during the scandal written by a former trader, suggesting that benchmark manipulation had been prevalent since 1991, nearly two decades before the US subprime sector crashed.

Fining the banks and jailing the ringleaders should have been enough but regulators turned on the benchmark itself, claiming that its very methodology was to blame, rather than the traders who exploited it.

The result is that 10 years on, the benchmark has gone through more reform than almost any other financial instrument — and rightly so. But one must question why carry out those reforms if Libor is about to be stripped of all relevance anyway?

The International Bar Association (IBA) implemented numerous reforms aimed at reducing the risk profile of Libor in 2016. Individual submissions are available to the Financial Conduct Authority, the IBA and an oversight committee, rates are submitted by a group now completely separate from the trading desk, and rates submitted are now based on actual transactions.

Gone are the days when traders could request submissions more in line with their ax sheet than the prices they were seeing in the market. Experts are arguing that this is enough to prevent manipulation, but regulators refuse to listen.

While overnight rates may be “the future”, as claimed by a recent FCA spokesperson at Barcelona Global ABS, they are quite untested and mean an uncertain future as teething problems emerge. Libor has been in use since 1968. Despite the reforms, it is still a familiar tool which may help stabilise a market fraught with Brexit and trade-war worry. 

Financial markets face all manner of difficulties in adopting new reference rates and, with a deadline of 2021 looming, still face a lot of work to iron out kinks in their adoption and in the novation of old deals on to new terms that don't feature Libor.

Faced with all that tumult, perhaps the new, improved Libor recipe can offer more sustenance than it is being given credit for.

By Tom Brown
30 Jul 2019