Libor is dead … long live NYbor?

London’s Libor will now be administered by NYSE Euronext

Uncertainty over the mechanism for calculating the Libor benchmark  in future remains in the wake of the generally applauded appointment of NYSE Euronext as its new administrator.

In June 2012, Libor was at the centre of a major scandal when it was revealed that the it had been used to commit fraud, illegally manipulate derivatives markets and deceive observers about the creditworthiness of various banks, all for the sake of financial gain by corrupt traders at Barclays and others.

Following a selection process overseen by HM Treasury and the Financial Conduct Authority through the  Tendering Advisory Committee chaired by Baroness Hogg, NYSE Euronext Rate Administration, a subsidiary of NYSE Euronext, was chosen to administrate Libor. The rate was previously administered by the British Bankers’ Association.

“This is the first step towards improving transparency and trust in the benchmark,” said Robert Emerson, head of interest rate derivatives at SuperDerivatives. “Despite its troubles, Libor remains one of the most critical interest rate benchmarks. In addition to the fixing of Libor becoming regulated, structural measures to prevent manipulation, appropriate monitoring processes, and potential criminal sanctions for manipulation are all needed. We need public and institutional confidence in both our banking system and the structure of our financial markets, and these structural and legal changes are a good step in that direction.”

However, it is still not clear exactly how the rate will eventually be calculated. It is understood that in the short term Libor will continue to be calculated by surveying banks. Martin Wheatley, chief executive of the UK Financial Conduct Authority, has expressed a preference for a benchmark more closely tied to real transactions.

According to Kevin Milne, chief executive at benchmark provider Rate Validation Services – which has been chosen as the software and services provider to NYSE Euronext – much has already been done to change the way Libor is created and disseminated . Most banks have moved the submission of rates away from the trading floors to separate departments, making it harder in theory for traders to influence the pricing process. Yet nothing at all has been done to change the actual calculation of the rates.

Were the industry to design a system from scratch today, the result would probably not be Libor. For example, the main source of bank funding in Europe today is the European Central Bank. The industry may not necessarily need Libor itself, but “it does very much need a rate that can be used as a reference point, and that rate needs to be as accurate and reliable as possible,” said Milne.

A change in the way the benchmark is calculated could mean that banks and their suppliers will feel the pinch as they need to change massive systems portfolios and data feeds. Thousands of applications, spreadsheets, databases and online web portals would need to be modified to bring legacy systems up to date.

Adding to the difficulties opposing a change are the costs that it would likely impose on investors with loan agreements pinned to Libor. That would involve re-evaluating existing contracts, possibly followed by redrafting/termination, in order to rebase the contract on a new benchmark.

A totally new system would not be the best solution either. “It’s very sensible to focus on achieving much better oversight of Libor and improving accuracy by adopting a more evidence-based approach than to throw away the whole thing,” said Milne. “There’s a huge demand from the industry for better prices. We are delighted that NYSE Euronext Rate Administration Limited have been selected. They have a profound understanding of Libor and related contracts and unparalleled experience of market operations.”

He added that valuing assets in the OTC markets can be difficult, especially if the instrument is a stock option that has only traded once in the last three months for example. Meanwhile, should banks be required to provide millions of price points per day, a spreadsheet-based system would be nowhere near enough to cope with the volume of information. Having an automated system should help to improve the efficiency and reliability of the information provided by Libor, he said. RVS will provide software and services to NYSE Euronext as part of the Libor administration deal.

Despite the uncertainty over the exact form the benchmark’s calculation will take in the longer term, NYSE Euronext has expressed its satisfaction at being chosen over rival applicants Thomson Reuters and the London Stock Exchange – and its confidence that it can play a positive role in returning trust to the battered benchmark.

“At the time of its publication, NYSE Euronext welcomed the findings of the Wheatley Review of Libor and today we are delighted to have been selected to become the new administrator for Libor,” said Finbarr Hutcheson, chief executive of NYSE Liffe. “We look forward to working with BBA LIBOR Ltd in completing the smooth transition to NYSE Euronext Rate Administration Limited, and continuing the process of restoring credibility, trust and integrity in Libor as a key global benchmark.”

In September, Wheatley was tasked together with Gary Gensler, chairman of the US Commodity Futures Trading Commission, to “identify relevant benchmark-related policy issues and develop global policy guidance and principles for benchmark-related activities of particular relevance to market regulators” by the International Organisation of Securities Commissions.

All remaining bank contracts with the BBA for Libor are expected to be transferred to NYSE Euronext by early 2014.