Lots more noise about LIBOR this week with Barclays performing the function of whipping boy for the popular press. Bob Diamond had a high profile and his confidence, which sometimes came across as arrogance, made the result inevitable.
We will not debate the rights and wrongs. Allegations of fixing were first reported by us a few months ago. Barclays may be the first but it will not be the last bank to be punished for being involved in this practice. It takes much more than one player to rig a market and RBS has already sacked four traders over the scandal. The main thing we now know for sure is that fixing did take place.
This story is still unfolding but what was the effect? What should corporates be checking and doing? The first task is to find out what exposure your company has or had to LIBOR and EURIBOR.
Firstly let us remind ourselves what LIBOR is. The London Inter-Bank Offer Rate is the average rate at which a leading bank can obtain unsecured funding in the London interbank market for a given period, in a given currency. Please note it is a lending (offer) rate not a deposit (bid) rate and is calculated by averaging the middle two quartiles of the rates submitted on a daily basis by a panel of 16 banks to the BBA (British Banking Association). The top and bottom quartiles are discarded.
There is sometimes talk of LIBID rates, the rates which banks are paying for funding (bidding on deposits) but in practice this is not a reference rate that is used. A bank’s deposit rate is whatever it is – typically rates paid on deposit accounts and the rate bid on money market deposits. It is LIBOR which is used as a reference rate for various financial arrangements, not LIBID, as bbalibor™ explains.
EURIBOR rates are set in much the same way. The FSA has made it clear in its final notice to Barclays that attempts were made to rig these rates as well.
Corporate exposure to the reference LIBOR and EURIBOR rates will typically arise in one of two ways.
Firstly a corporate might have LIBOR (or EURIBOR) related borrowings. Now given that most of the allegations are that the dealers rigged the rates lower than they should have been this may not be a problem. You may have borrowed at a lower cost. At least some of the time the rates were rigged, the interbank market was illiquid and inter bank credit lines were being cut. As a result LIBOR rates were all over the place and some banks had to pay a little more to fund themselves. The allegation is that, when reporting LIBOR, individual trader low-balled the figure rather than let others know they were paying a premium over the market. This story will change as the time period for alleged rigging extends (rates were rigged as far back as 2005 according to the FSA) and when and if allegations of rigging higher LIBOR rates are proven.
LIBOR and EURIBOR are also used as reference rates in many derivative products, including swaps. Put at its simplest, you will have exposure to LIBOR (or EURIBOR) if what you pay or receive is related to LIBOR (or EURIBOR). Once again if this is paying, you may have benefitted if the rates were lower than they should have been. And vice versa if you were receiving a LIBOR derived income.
Naturally, it also depends on whether you were hedging and had an offsetting cost or income that was also LIBOR-based. In short, if you receive LIBOR-based income in some way you may have lost. But of course we are only talking basis points at the moment and the actual cost will only be significant if the volumes are very large.
You may be cash rich as a company and investing in the money markets but you will not be investing in products priced off quoted LIBOR reference rates. Typically you will be quoted the going rate by the bank (or the broker) at the time you make a deposit or buy a CD. For much the same reasons money funds are largely unaffected by the allegations of rate fixing. Nor does the fixing, as currently disclosed, have much influence on base rates.
This LIBOR story has much longer to run but corporates should be quantifying now if they have any exposures to LIBOR and whether these might have resulted in any additional costs (or benefits).
In the longer term the calculation of LIBOR might be better off if it was based on traded volumes and rates at which deals were actually done. SONIA (Sterling Overnight Interbank Average Rate) and EURONIA (volume weighted average interest rate for unsecured overnight euro deposits arranged by eight money brokers in London) are calculated in this way but it would mean more reporting if LIBOR was to be based on this method.
And finally those who have been falsifying returns should be prosecuted.
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