February 26, 2013
Good afternoon, I want to welcome all of you to the Commodity Futures Trading Commission (CFTC) for today’s roundtable. This is the 23rd roundtable that we’ve had at the CFTC in the last couple years. This one is a little different. Most of our roundtables have been focused on Dodd-Frank swaps market reform. Today’s roundtable is about the integrity of financial market benchmarks.
The CFTC and the Financial Services Authority (FSA) are co-chairing the International Organization of Securities Commissions (IOSCO) Task Force on financial market benchmarks. The task force is developing international principles for benchmarks and examining best mechanisms or protocols for a benchmark transition, if needed.
In January, the task force published the Consultation Report on Financial Benchmarks, and a final report will be published this spring. Last week, we held a very productive roundtable in London to get public feedback for the final report. We also wanted to offer an opportunity for public input here in the United States.
I want to thank Martin Wheatley and all of his colleagues at the FSA for their partnership on this task force effort, as well as vigorously pursuing enforcement cases regarding manipulative behavior surrounding the London Interbank Offered Rate (LIBOR) and other similar rates.
Jackie Mesa, Robert Rosenfeld, Matthew Hunter and Richard Haynes from the CFTC are going to walk you through various questions in the consultation, which come down to five key areas:
“[A] benchmark should as a matter of priority be anchored by observable transactions entered into at arm’s length between buyers and sellers in order for it to function as a credible indicator of prices, rates or index values.”
In addition, to the extent that there are short time periods with an insufficient level of actual transaction data, to what extent might non-transactional information, such as bids and offers and various extrapolations, be referenced?
Prospectively, the consultation suggests that contracts referencing a benchmark would be more resilient if those contracts had embedded in them a contingency plan for when a benchmark may become obsolete.
And perhaps more challenging, the consultation asks what to do about existing contracts that reference a benchmark that becomes obsolete, if those contracts don’t have an effective contingency plan.
I agree with the consultation report’s statement that for any benchmark to be reliable and have integrity, it’s best to be anchored in real, observable transactions. It’s only through real transactions entered into at arm’s length between buyers and sellers that we can be confident that prices are discovered and set accurately.
When market participants submit for a benchmark rate that lacks observable underlying transactions, even if operating in good faith, they may stray from what real transactions would reflect. When a benchmark is separated from real transactions, it is more vulnerable to misconduct.
As we examine these questions and the IOSCO consultation, I think it’s important to keep in mind what we’ve learned to date.
Foremost, LIBOR and other such rates around the globe may no longer be grounded in real transactions. The market for interbank, unsecured lending has largely diminished over the last five years. Some say that it is essentially nonexistent. In 2008, Mervyn King, the governor of the Bank of England, said of LIBOR: “It is, in many ways, the rate at which banks do not lend to each other.”
The number of banks willing to lend to one another on unsecured terms has been sharply reduced because of economic turmoil, including the 2008 global financial crisis, the European debt crisis that began in 2010 and the downgrading of large banks’ credit ratings.
In addition, there have been other factors, including central banks providing significant funding directly to banks, banks managing demands on their balance sheet, as well as recent changes to Basel capital rules.
We also have learned that LIBOR – central to borrowing, lending and hedging in our economy – has been readily and pervasively rigged.
At the three banks fined for manipulative conduct by the CFTC, the FSA and the Justice Department, the misconduct spanned many years, took place in offices in several cities around the globe, included numerous people, and involved multiple benchmark rates and currencies. In each case, there was evidence of collusion.
In the UBS and RBS cases, one or more inter-dealer brokers were asked to paint false pictures to influence submissions of other banks, i.e., to spread the falsehoods more widely. Barclays and UBS also were reporting falsely low borrowing rates in an effort to protect their reputation.
We also can observe a significant amount of publicly available market data that raises questions about the integrity of LIBOR today. A comparison of LIBOR submissions to the volatilities of other short-term rates reflects that LIBOR is remarkably much more stable than any comparable rate.
Furthermore, a comparison of LIBOR submissions to the same banks’ credit default swaps spreads or to the broader markets’ currency forward rates highlights a continuing gap between LIBOR and what those other market rates tell us.
This IOSCO consultation comes at critical juncture.
Given what we know now, it’s critical that we move to a more robust framework for financial market benchmarks, particularly those for short-term variable interest rates.
Given what we know now, it’s critical that we discuss procedures and mechanisms for transitioning from those benchmarks that become unreliable or obsolete.
Thank you again for coming today, and I look forward to your feedback.
Last Updated: February 26, 2013