Banks identify possible replacements for U.S. Libor

[May 21, 2016]  By Richard Leong
 
 NEW YORK (Reuters) - A group of global banks and clearing houses, working with U.S. regulators, said on Friday it has identified two possible replacements for Libor, the benchmark interest rate for $160 trillion worth of credit for everything from home mortgages to corporate loans.

The Alternative Reference Rates Committee (ARRC) said that together with the Federal Reserve it has identified the Fed's Overnight Bank Funding Rate (OBFR) and the overnight rate on U.S. Treasury securities pledged as collateral in repurchase, or repo, transactions as alternatives.

The London Interbank Offered Rate has been in regulators' cross hairs since its credibility was tarnished by a rate-rigging scandal emerging from the 2008 financial crisis. About a dozen global banks collectively have paid tens of billions of dollars in fines to settle the matter.

"The case for moving ahead to a new benchmark is very strong. The new benchmark is going be robust with a lot of transactions and will be resistant to manipulation," Fed Governor Jerome Powell told Reuters.

ARRC said the two rates it identified as replacements represent "robust" markets, each with $300 billion worth of daily trades. Bankers and regulators have raised alarms about diminishing daily liquidity in the markets for unsecured loans like Libor, calling into question their reliability as a gauge for U.S. borrowing costs.

The stakes are large: Libor's benchmark 3-month rate stands as a reference rate for pricing $160 trillion of loans in the United States and, together with companion rates in Europe and Asia, has some $350 trillion of global credit tied to it.

"Having a viable rate alternative is important to financial stability especially if Libor activity were to cease at some point," Sandie O'Connor, the committee's chair and chief regulatory affairs officer at JPMorgan Chase <JPM.N> said on a call with reporters.

The group proposed a framework to phase in the new reference rates to minimize disruptions to financial markets. The plan would allow Libor-linked transactions to exist while the new benchmarks gain acceptance by dealers and investors.

"The ARRC envisions a paced transition focusing on new transactions rather than a 'big bang' that would seek to change existing trades," it said in a reported released on Friday.

ARRC comprises 15 large global banks, which are also interest rate derivatives dealers along with the Fed, the U.S. Treasury Department, the Commodity Futures Trading Commission and the New York Fed. Clearing houses such as Bank of New York Mellon, CME and LCH.Clearnet are also part of the group.

ARRC's effort began in November 2014 and parallels those by authorities in Britain, Japan, Switzerland and the euro zone.

The committee said it picked OBFR and secured general collateral lending rates over four others: monetary policy rates like the fed funds rate; Treasury bill or bond rates; term overnight index swap (OIS) rates and term-unsecured lending rates. These others suffer from smaller market sizes, as well as likely fluctuations in monetary policy framework and issuance.

OBFR, developed by the New York Fed, launched in March and reflects $300 billion of daily trades. The interest rate on secured general collateral repurchases, in which banks and dealers use Treasuries as collateral to borrow from investors, is of a comparable size.

The Fed and Office of Financial Research are currently considering producing an index on the Treasury repo rate.

“The plan is for the committee to pick a rate later this year with the expectation that trading in the new rate could begin as early as next year,” Fed's Powell said.

The New York Fed's overnight bank funding rate stood at 0.37 percent on Thursday, unchanged since May 2.

In the repo market, the general collateral rate was last quoted at 0.37-0.38 percent, unchanged from Thursday, according to ICAP.

It is unclear how quickly investors would accept a replacement to the 30-year old rate benchmark with its entrenched status around the world.

"It's got an uphill battle. I can't see a massive move to the new rate from Libor right now," said David Keeble, global head of interest rate strategy at Credit Agricole Corporate & Investment Bank in New York.

(Reporting by Richard Leong; Editing by Dan Burns, Meredith Mazzilli and Chizu Nomiyama)

[© 2016 Thomson Reuters. All rights reserved.]

Copyright 2016 Reuters. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.