FIXED INCOME SECURITIES

Topic: LIBOR History and Relevance

SAKSHAM CHOUDHRY 2020PGP036
AYAN JAIN 2020PGP076
OMKAR INGALE 2020PGP091
SAAKSHI MALPANI 2020PGP104
SANCHIT CHANDNA 2020PGP107
VASUNDHARA MISRA 2020PGP182
ASHISH 2020PGP196
What is LIBOR?

Implications of using LIBOR:- Evaluating the alternatives:-

Various Alternative Reference Rates (ARR) have been pushed
into the system to transition from LIBOR towards more
regulator-backed lending rates. Secured Overnight Financing
Rate (SOFR)-US, published daily by the New York Federal
Reserve Bank, based on data collected on secured overnight
repurchase transactions (backward-looking metric),
and Sterling Overnight Interbank Average Rate (SONIA)-
UK, a transaction-based benchmark that reflects the average
interest rates that banks pay to transact sterling overnight
have emerged as popular ARR’s. Lenders evaluate index rates
such as the American Interbank Offered Rate (Ameribor) or
the Bloomberg Short Term Bank Yield Index (BSBY) as
alternatives. Still, the quantum of transactions linked to it
remains small. Also, ‘Term SOFR’ has been introduced by
CME Group Inc. to help corporates anticipate interest rate
risk by making SOFR more forward-looking and giving
corporates to predict interest rate risks.

Why LIBOR started losing its relevance? (LIBOR Scandal)

Around 2003, the LIBOR rate was manipulated by many of Barclays’ traders by asking their banks LIBOR rate contributors to
indulge in influencing the rates based on the trading positions. Banks such as Barclays were also involved in manipulating the
LIBOR rates during the financial crisis (2007-2008) by submitting artificially low LIBOR estimates.

We can understand the mechanism of manipulation of the LIBOR rates by looking at the case of Thomas Hayes, a former
trader at both UBS Group and Citigroup Inc. Hayes had come across almost 16 individuals who were responsible for making
their bank’s daily submission for Japanese Yen. Hayes came to the realization that these men were guided by the interdealer
brokers who told them what to submit each day. Given this, Hayes used to convey his LIBOR yen target to the brokers.
Whenever a bank contributor turned to the interdealer brokers to get an opinion on LIBOR’s direction, the dealers went with
Hayes’ targets. This way, depending on the LIBOR rate, Hayes’ profit (or loss) moved from 20 million dollars loss to 8 million
profits.

Aftermath of LIBOR manipulation:-

When the regulatory authorities of Europe and the US led an investigation into the scandal, almost a 9 billion dollar fine was
imposed on banks such as Barclays, JP Morgan, Citigroup and others. Due to the misconduct, the replacement to LIBOR
started being considered. However, later it as suggested that the LIBOR measures should be retained but the rate
submissions be backed by correct data. A new firm named Intercontinental Exchange was constituted to administer LIBOR.
The benchmark was renamed as ICE LIBOR (from BBA LIBOR). ICE LIBOR used five currencies to fix the rate, namely, Euro,
Pound, Yen, Swiss Franc and Dollar. A panel of around 11-18 bank contributors was maintained for each currency. Later, in
the year 2015, a working group was constituted to come up with an alternative to LIBOR. However, by 2016, the group did
not come up with any such alternative. Instead other benchmarks (like OIS) were suggested.