What Will Happen With LIBOR?

All of the continuing examinations into assumed manipulation of Libor cause the uncertainties about its use as a standard, which is still extensive, as well as the research within the potential alternatives on the market, such as overnight indexed swap rates. The possibilities of manipulating the Libor fixing rates are investigated climbs the headlines these days, but there are already those who say that in the post-Lehman are the same questions about using such rate as the suitable standard and the alternatives potentially available on the market.

perperzona52763chartIf there can be summarized the main points of weakness of the instrument, there could be seen the outdated nature, having been created in 1985 as a general rate of dollars for the offshore market – the Eurodollar, and, besides, the method of estimate as the average of daily guidance, provided in response to a question which has become irrelevant, such as at what rate one could borrow funds, asking for and then accepting offers between banks in reasonable market size, and a series of international banks, excluding the highest and the lowest. There is also the lack of a reference to securities actually traded. Given these defects, making it vulnerable to potential manipulation of course, are awarded to the Libor some strength. On the other hand, the methodology of calculation is transparent, given that all values that are complete by the contributors are public, and then also Libor is a rate that reflects both rate expectations, but also the risk premium term arrangement of money market instruments, such as credit in the private sector. Lastly, the historical evidence proves that the Libor fixings are usually always been very close to the rates published for instruments actually traded anymore, and what can be inferred that actually represents well the money market conditions. However, there is another implication of Libor that is absolutely unquestionable regarding the use of Libor that is persistent, that is so common, even and especially in the over-the-counter derivatives market that it is in fact difficult to replace.

Conversely and the most likely it can be transformed and with this purpose there could already be predicted that all the solutions that will be deliberate in this regard will be a fair compromise between the importance of maintaining the character of the Libor rate as unsecured, that therefore includes an element of credit, as well as the require to give greater credibility to the instrument by reference to a market rate negotiated extensively. In this regard it seem that there exist the two alternatives, where the first one involves trying to generate an active market for trading of Libor, with daily auctions in which banks of the panel involved bank rates on commercial paper, and not general references in order to maintain the position to bank credit, wile the other possibility is to assign a standard to Libor actually negotiated, that came without replacement, avoiding problems on existing contracts, that are often have extended maturity and trying to continue to return the term premium money market. The first one should find support from the international banks, while the second may create discontinuity and loss of information on the term structure of bank credit, bringing the Libor fixing even more close to overnight indexed swap rates. The question is would the awaiting reform of Libor act as operators on the market, as it would seem that the use of different Libor rates is scattering.

According to the London Clearing House, the swaps that are oriented to the overnight indexed swap are at this time about one third of total daily volume and considering the volumes already in circulation, it is estimated already constitute 14 percent of the total existing swap. If it only refers to volumes that often do not express the whole story, since the Depository Trust and Clearing Corporation shows that, at the end of June, the interest rate swaps based on overnight indexed swap are highly concentrated on a shorter time, that is one or two years. However, the swap market on a long o even longer period of time still continues to use Libor as a reference rate, which, in fact, validates the above mentioned in terms of considerable exceptional instrument in the short to medium term.

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