Investors Expect Libor to be Replaced Within Five Years

Friday, 07 Sep 2012 07:37 AM

 

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A key interest rate for more than $500 trillion of securities worldwide will be replaced by a benchmark subject to greater government control, according to a plurality of global investors.

Forty-four percent of those responding to a quarterly Bloomberg Global Poll said the London interbank offered rate, known as Libor, will be supplanted by a more regulated model within five years. Thirty-four percent predicted the rate will continue to be set by banks in the current fashion, while 22 percent said they didn’t know.

Confidence in Libor has waned as authorities investigate whether financial firms rigged the rate to profit on derivatives positions and hide how difficult it was for them to borrow money during credit-market turmoil in 2008.

Barclays Plc, the U.K.’s second-largest bank by assets, agreed to pay $460 million in June for its role in fixing the rate, prompting lawmakers, regulators and investors to question the veracity of a benchmark that is pegged to securities ranging from home mortgages to credit cards.

“The Libor scandal should not be something to be hidden under the carpet because it affects the correct functioning of financial markets and the economy as a whole,” said Mario Cribari, head of asset management at Veco Invest SA in Lugano, Switzerland, and a participant in the poll. Governments are trying to intervene “to calm public anger,” he said.

The quarterly poll of 847 investors, analysts and traders who are Bloomberg subscribers was conducted Sept. 4.

Ongoing Probe

Libor is derived from a survey of banks conducted each day on behalf of the British Bankers’ Association in London. Lenders are asked how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies including dollars, euros, yen and Swiss francs. After a set number of quotes are excluded, those remaining are averaged and published for each currency by the BBA before noon.

Investigators have focused on instances of traders coordinating submissions in order to earn profits on derivatives tied to the rates for dollars, euros and yen. The probe, which is ongoing, has ensnared banks including UBS AG, Citigroup Inc., Royal Bank of Scotland PLC, Deutsche Bank AG, and HSBC PLC, according to company filings.

Meanwhile, regulators including the U.K.’s Financial Services Authority have started broader reviews of how the rate is determined and regulated. The European Commission said Sept. 5 it is also seeking views on possible rules, including forcing banks to provide real transaction data rather than estimates and increasing the number of lenders involved in setting the rate.

‘Watered Down’

The proportion of poll respondents predicting that Libor would be replaced was consistent across the U.S., Europe and Asia.

“There will be the traditional U.K. process of an inquiry that makes few meaningful recommendations, which will then be further watered down to the point that any changes will be both minimal and satisfactory to nobody,” said Oliver Attwater, a London-based North America equity analyst for British Airways Pensions Investment Management Ltd.

The BBA, which represents more than 200 banks and lobbies policy makers and regulators on behalf of the industry, has been faulted for failing to fix Libor in 2008 when the Bank for International Settlements first raised concerns that the benchmark was being manipulated.

Geithner Testimony

According to U.S. Treasury Secretary Timothy Geithner, private, unregulated organizations such as the BBA shouldn’t be responsible for rates such as Libor.

“We have to take a careful look at other parts of the financial system where the markets rely heavily on private organizations composed of private firms like the BBA that have some quasi-regulatory or self-regulatory role,” Geithner told the Senate Banking Committee in Washington in a July hearing to discuss the Barclays settlement. “As you’ve seen in this case, we’ve got to be careful to make sure the system is not relying on associations of private firms that leave us vulnerable to the kind of things we’ve seen.”

In a Wall Street Journal editorial Aug. 2, Dan Doctoroff, chief executive officer of Bloomberg LP, the parent of Bloomberg News, proposed an alternative to Libor dubbed the Bloomberg Interbank offered Rate, or Blibor, and offered to manage it as a service to global financial markets.

In answering a separate question about the securities markets, global investors expressed skepticism about the growth of high-frequency trading that uses computer algorithms to buy and sell stocks in fractions of a second. Fifty-five percent said the practice, which now accounts for more than half of equity trading volume, is having a mainly negative impact.

Regulatory Focus

Regulators have sharpened their focus on algorithmic and high-frequency trading since May 6, 2010, when a computer program employed by one firm sparked a 20-minute plunge in stock prices, temporarily erasing $862 billion of market value. The issue emerged again last month when a software malfunction at Knight Capital Group Inc. cost the company $440 million and left it looking for a financial infusion.

Thirty-seven percent of survey respondents said high- frequency and algorithmic trading is mostly bad because it makes markets more volatile, and 18 percent said it was negative because computer problems could hurt investors.

“In today’s market, emotions appear to drive investor decisions more than fundamental rationale,” said Jon Morris, a portfolio manager at Palladium LLC in Norfolk, Virginia. “Trading by algorithms and with high frequency clearly is skewed away from fundamentals. When algorithms are right for the wrong reason, it only increases investors’ abandonment of sound judgment.”

Traders More Positive

Proponents of high-frequency trading say it makes markets more liquid, lowering transaction costs for investors. Thirty- six percent of respondents said that the practice was mainly positive. While 30 percent of U.S.-based respondents said high- frequency trading was mostly good, 42 percent of participants in Asia viewed it positively.

Across professions, 40 percent of traders and market makers surveyed said high-frequency trading is good, compared with only 31 percent of portfolio managers and asset liability managers who shared the view.

The Bloomberg Global Poll was conducted by Selzer & Co., a Des Moines, Iowa-based firm. The poll has a margin of error of plus or minus 3.4 percentage points.


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