Last year saw a huge shock for the financial world. When I say shock, I mean one of many shocks which have caused financial markets react in unexpected ways over the past few years. The fixing of LIBOR by a few banks has been called one of the most heinous acts of Wall Street, and had the effect of shortchanging small investors. The LIBOR rate was fixed based on calls made by British Bankers Association (BBA) throughout the day so there was an opportunity to misguide the market by those few banks, in order to gain some advantage over others.
Now it seems that the NYSE Euronext will be given the responsibility of setting the rate and straight out of the gate, it can be seen that there is a conflict of interest as NYSE Euronext is the biggest market maker in short term interest rates. It is the market that is based on the LIBOR and uses the rate to price the different products that are traded under it. The company is also the operator of the NYSE and will be responsible for the $300 trillion of securities which are based on the rate, one way or the other.
Supporters say that being responsible for LIBOR, and being the largest party exposed to the rate, the company will try to retain some of the confidence that was associated with the rate and will use it to curb doubts that the investors may still have regarding the pricing mechanism.
An example can be an oil company using a commodity for its own use and having the responsibility to improve the profile of the commodity throughout society as well. There is a higher concern to raise the reputation of the rate to what it once was, and practical efforts in this regard still need to be demonstrated in order to make an authoritative claim of integrity.
The old mechanism for setting the rate was based on a poll taken by the BBA resulting in a consensus and that is the purist’s way of establishing this rate. However NYSE is looking into developing a process that is transparent, but supervised, so that manipulations cannot take place. With the reputation of LIBOR as it is, NYSE Euronext also expects to feel extra scrutiny for some time before the rate receives approval from stakeholders.
In the scandal that took place last year, RBS has already come out in amidst the fines that were imposed on them saying that it did carry out at least 219 documented inaccuracies in setting the LIBOR. It admits that its derivatives traders were allowed to talk to LIBOR submitters and were able to get a rate that favored them. They were fined USD 612 million for fixing the rate.
Critics of LIBOR still say that the mechanism used is obsolete and rather than creating a consensus of the banks views, real data should be used from recent trades in the market, in order to set the price. An analogy would be; rather than setting the rate on what the shop owners want to get for a product, the price gets set on the price the product actually gets at the cash register. This would restrict manipulations that were seen before. The change that has taken place is just a change of administration, and that if the system being followed is the same, then there is no actual change that has taken place. This change seems superficial and does not address the underlying and fundamental problems.
“If you keep on doing what you have been doing, you will keep on getting what you have been getting.” — Jackie B. Cooper
This is a bittersweet moment for the financial world. On one hand, there is a responsibility and an urge for some change to take place so that no such incidents can take place in the future, but the method followed is not the best one available. If the system is kept the same and only the leadership is changed, then there would be no actual benefit. There is a need to do more and it can be done right now when the outcry is this loud. Compromises and sacrifices can be made right now, and all issues can be addressed before a final decision is reached. If these concerns are not fulfilled, the consent will gather momentum over time and another meltdown will be inevitable in the near future. It is high time that the disease is actually diagnosed and cured — rather than doing a quick patch-up to hide the wounds.
© Zain Naeem