December 5, 2021

High & Low Finance: Steering a Better Course Past the Fiction of Libor

Libor, if you have not been paying attention, is the London interbank offered rate — or rates, since there are dozens of them. For decades, it has been the dominant determinant of floating interest rates, with trillions of dollars in loans and derivatives priced off those rates.

Now it is ridiculous. It purports to be the rate at which banks can borrow, without collateral, from each other. Every day banks submit the rates at which they could borrow money, on an unsecured basis, in various currencies and varying maturities. Those rates are averaged, after the highest and lowest ones are eliminated, and that becomes that day’s Libor rate.

These days there is a problem: banks almost never borrow from each other, particularly at longer maturities. So the rates are fictitious — or at least not based on any information that could be verified.

Before, during and after the credit crisis, the rates were being manipulated by bankers, often with the approval of top management. Sometimes the motive was to make the bank look better — what does it say about a bank if its peers evidently will not lend money to it at the same rate they will lend to others? — but other times the motive was just to rig markets so traders could make money. It was sort of like betting on a soccer match: profits are much more likely if you fix the match before you place your bet.

Three major banks — Barclays, UBS and the Royal Bank of Scotland — were fined a total of $2.5 billion by authorities in Britain and the United States. It appeared to be a case of international regulatory cooperation at its best.

But now that cooperation is breaking down. In the United States, Gary Gensler, the chairman of the Commodity Futures Trading Commission and the man whose determination to do something helped to expose criminal behavior that evidently did not seem all that outrageous to some others, is pushing to get rid of Libor entirely. He argues that it no longer really exists, assuming it ever did, and wants to find a new benchmark for floating interest rate contracts.

But Britain and the European Commission appear to be determined to save Libor, whether or not it really means what it is supposed to mean. This week new governance rules took effect in Britain, and the European Commission is moving in the same direction. The new rules call for better governance, with efforts made to assure there is no cheating by traders.

Some banks, understandably, would just as soon get out of a business that has sullied reputations and cost billions. Some have tried to resign from the panels that determine Libor and its cousin, Euribor, a similar but less widely used system of base rates. But both European and British regulators view the existence of the benchmarks as critical and have warned banks not to leave.

“Interbank interest rate benchmarks are of systemic importance,” said Michel Barnier, the European commissioner in charge of markets. He said European legislation would force banks to submit rates.

To Mr. Gensler, the American regulator, the Europeans are moving in the wrong direction. “We have seen a significant amount of publicly available market data that raises questions about the integrity of Libor today,” he said in a speech last month. He said that there was very little unsecured interbank trading going on, and that even when other interest rates fluctuated widely — rates that include credit-default swaps on the very same banks — each bank tended to submit the same rates day after day.

He noted that a task force of the International Organization of Securities Commissions recommended earlier this year that “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,” adding, “I agree with this.”

To put it mildly, there is no reason to think the interbank lending market fits that bill now, and there are reasons to think it will be even less true in the future. Mr. Gensler said some banks believed the new Basel capital rules regarding liquidity would make it prohibitively expensive for one bank to lend to another for more than 30 days at a time. If so, there will be no such lending.

Mr. Gensler would like to develop an alternative and points to two options. One would essentially be dependent on the Federal Reserve’s setting of the federal funds rate — the rate at which it will lend to banks. The other would be based on rates charged on secured loans. In each case these are real markets, at least in dollar-based transactions. He would like to phase in one of them as a replacement for Libor.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/04/05/business/steering-a-better-course-past-the-fiction-of-libor.html?partner=rss&emc=rss

DealBook: Regulators Approve New Rules for Derivatives

Under the plan, wide swaths of non-financial companies, like Ford, are excused from certain provisions under Dodd-Frank.John Sommers II/ReutersUnder the plan, wide swaths of non-financial companies, like Ford, are excused from certain provisions under Dodd-Frank.

3:57 p.m. | Updated

Regulators on Tuesday took a major step toward reining in risky Wall Street trading, approving new rules aimed at preventing a repeat of the financial crisis.

The rules, stemming from the Dodd-Frank financial regulatory law, will give regulators more control over the $700 trillion derivatives industry, an opaque business at the center of the crisis. While regulators have spent more than two years retooling the sector, the latest package of reforms laid crucial building blocks for the remaining aspects of the Wall Street overhaul.

“Light will begin to shine on the markets for the first time,” Gary Gensler, chairman of the Commodity Futures Trading Commission, which approved the rules, said at a public meeting. “This is a very significant day for the American public.”

But another member of the agency questioned whether last-minute changes undermined the rule, allowing risk to seep back into the system. Bart Chilton, a Democratic commissioner who cast the lone vote against the plan, raised concerns that the fine print created loopholes wide enough for Wall Street to exploit.

“There are lots of lawyers out there itching to find ways for their clients to get around Dodd-Frank,” said Mr. Chilton, an outspoken advocate of regulation who never before voted against a final Dodd-Frank rule.

Capping months of frenetic corporate lobbying, the agency on Tuesday also approved a set of policies spelling out a key exemption from regulation. Under the plan, wide swaths of non-financial companies and small banks are excused from certain provisions under Dodd-Frank. The carve-out, regulators say, would exclude from some oversight about 30,000 manufacturers, gas companies and airlines, including companies like Ford and Exelon.

The vote came nearly two years after Congress enacted Dodd-Frank, which for the first time mandated an overhaul of swaps trading, the derivative contracts tied to the value of commodities, interest rates and mortgage securities. One form of derivatives, credit-default swaps, nearly toppled the giant insurer American International Group and deepened the financial crisis.

Under Dodd-Frank, big banks and other financial institutions must submit certain derivatives contracts to regulated clearinghouses, which serve as a backstop in case one party in the trade defaults.

But Wall Street was in a holding pattern until regulators took action on Tuesday. The new plan, which defined key derivatives terms like “swap,” will now trigger a cascade of other Dodd-Frank measures. The definitions underpin the law, ushering in a requirement that big banks like JPMorgan Chase register with regulators. The definitions also lay the groundwork for a battery of reporting requirements, risk management procedures and ultimately capital standards. Some requirements will kick in about two months from now.

“There’s no question this is an incredibly foundational rule for the industry,” said Gabriel D. Rosenberg, an attorney at Davis Polk, which represents some of the biggest names on Wall Street. “The clock has started ticking and it’s a clock with a very short fuse.”

The agency said its definitions would cover most known swaps contracts while excluding insurance products, so-called forward deals and consumer transactions, like contracts to buy home heating oil. The Securities and Exchange Commission unanimously approved a similar version of the rule last week.

“By finalizing these rules, we are completing the foundation of a new regulatory regime intended to reduce systemic risk and bring greater transparency to this multi-trillion dollar market,” Mary L. Schapiro, the S.E.C.’s chairwoman, said in a statement.

But Mr. Chilton questioned whether the exclusions were overly broad, going beyond what the S.E.C. agreed to last week. Indeed, the Commodity Futures Trading Commission delayed its Tuesday meeting nearly an hour to hammer out a last-minute compromise over the minutiae of the rule.

“One man’s loophole is another man’s livelihood,” Mr. Chilton said.

Separately on Tuesday, the Commodity Futures Trading Commission unanimously approved a broad exemption from the requirement that derivatives trades go through regulated clearinghouses. The rule, the subject of more than a year of fierce lobbying from some of the nation’s biggest corporations, was meant to shield companies from the burdens of Dodd-Frank.

It applies to “commercial end users” – an array of oil companies, airlines and other firms that use swaps to counteract risk associated with a potential swing in value of goods that they purchase or manufacture. An airline, for instance, uses swaps to hedge against the fluctuating cost of jet fuel. Commercial companies also buy swaps to protect against jumps in interest rates.

Under the agency’s final rule, swaps need not go through clearinghouses if at least one party in the trade is a “non-financial” entity and is using the swap to hedge against “commercial risk.” The exempt firms, which are expected to number 30,000, must still alert regulators when they enter into swap transactions.

Regulators also extended the exemption to small banks and other financial firms outside the glare of Wall Street. The final rule allowed the firms with total assets of $10 billion or less to qualify for the end-user exception.

With the rules receiving approval, the agency further whittled down its lengthy list of Dodd-Frank responsibilities. The agency, Mr. Gensler said, has blessed some 35 final rules with about 15 remaining.

“Just by the math you can see we’re quite a way into this,” Mr. Gensler said.

“But I think it is critical we finish the job, protect the market and promote more transparent and healthier markets.”

Article source: http://dealbook.nytimes.com/2012/07/10/in-new-rules-to-shine-light-on-derivatives-regulators-also-allow-exemptions/?partner=rss&emc=rss

Lawmakers Seek Assurances on Bank Regulations

Harmonization has been a top consideration in international talks related to how much capital the biggest banks must maintain and methods for orderly wind-downs of large firms, several officials told the House Financial Services Committee on Thursday at a hearing in Washington.

Representative Spencer Bachus, the Alabama Republican who leads the Financial Services Committee, conducted the hearing amid complaints from bankers that American regulations being imposed under the Dodd-Frank act might slow economic recovery from the 2008 financial crisis and drive business overseas. Lawmakers sought assurances that regulators were looking out for United States interests in dealing with their international counterparts.

“Dodd-Frank was not passed in the E.U., and it was not passed in the G-20, so our regulators must take great care,” Representative Jeb Hensarling, the Texas Republican who serves as financial services vice chairman, said referring to the European Union and the Group of 20 nations.

The six regulators who appeared before the panel agreed that they planned to ensure a level playing field in rules, including those for the $601 trillion global swaps market.

“The best national regime in the world is not going to be adequate if other countries do not adopt robust resolution tool kits and complementary authorities,” said Lael Brainard, the Treasury under secretary for international affairs.

She was joined at the hearing by Daniel K. Tarullo, a Federal Reserve governor; Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corporation; Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission; Gary Gensler, chairman of the Commodity Futures Trading Commission; and John Walsh, acting comptroller of the currency.

The international Basel Committee on Banking Supervision agreed last year to raise the minimum common equity requirement for banks to 4.5 percent from 2 percent, with an added buffer of 2.5 percent, for a total of 7 percent of assets weighted for risk.

The Basel members are also proposing that so-called global systemically important financial institutions hold additional capital.

“What is important is not to lose sight of the costs of not acting,” Mr. Tarullo said at the hearing. The surcharge based on some studies may be as high as seven percentage points above the Basel requirement, he said, adding that the final figure, now under consideration by regulators, may not reach that level.

American regulators have yet to align themselves on the issue, with Ms. Bair pushing higher capital levels for the largest banks and Mr. Walsh, who oversees national banks, urging caution as talks over rules continue.

“I’m concerned with how much further we can turn up the dial without negative effects on lending capacity,” Mr. Walsh told lawmakers. “A very real risk is that lending will fall, will become more expensive and will again move from the regulated banking sector into the less-regulated shadow banking sector.”

The committee also heard testimony from a second panel including executives at JPMorgan Chase and Morgan Stanley as well as an associate general counsel at the A.F.L.-C.I.O.

The banking officials argued that certain derivative rules will push business outside of the United States.

Representative Barney Frank of Massachusetts, the senior Democrat on the Financial Services panel, told regulators they should not let concerns over bank profits affect their decisions.

“They are the means to a sound financial system, they are not the end,” said Mr. Frank, who co-sponsored the financial regulation law that bears his name. “Their profitability in and of itself is not important to anyone other than themselves.”

Article source: http://feeds.nytimes.com/click.phdo?i=f467e7e7345f3641a25410d93d543553

DealBook: Derivatives Market Faces New Capital Rules

Gary Gensler, chairman of the Commodity Futures Trading Commission.Evan Vucci/Associated Press Gary Gensler, the C.F.T.C.’s chairman, is worried that the proposed capital rules are too lenient on the industry.

7:51 p.m. | Updated

The $600 trillion derivatives market, long known for its freewheeling ways, is slowly being tamed.

The Commodity Futures Trading Commission proposed rules on Wednesday that would force hedge funds and other firms that trade the opaque products to bolster their capital cushion, the latest effort by regulators to curb risky behavior that fed the financial crisis.

The commission also issued a long-awaited clarification about what types of derivatives contracts will face new regulations.

The new capital rules are largely aimed at some 200 swap dealers — brokerage firms, large energy trading shops and Wall Street affiliates that arrange the deals. The commission’s plan also would apply to hedge funds and other companies that have huge positions in swaps, the derivative contracts tied to the value of commodities, interest rates or mortgage securities.

Gary Gensler, the commission’s chairman, said the capital rules would “help protect” companies and other market participants. But he also questioned the rigor of the requirements, saying at the commission’s public meeting on Wednesday that “my worry” is that the proposal is too lenient on the industry.

That concern was echoed on Wednesday by advocates of financial reform.

Despite the controversy, the agency’s commissioners voted 4 to 1 in favor of advancing the proposal to a 60-day public comment period. They are expected to vote on a final version of the rules by the fall.

Scott D. O’Malia, one of the agency’s two Republican commissioners, voted against the plan. Some Republicans lawmakers, meanwhile, have introduced measures in Congress to delay or derail the capital requirements and other commission rules.

The proposed rules come out of the Dodd-Frank Act, the financial regulatory law enacted last year. The law mandated an overhaul of swaps trading, an unregulated industry that was at the center of the crisis. The commission over the last year has proposed dozens of new derivatives regulations, including a plan that would require many swap contracts to be traded on regulated exchanges.

But for months, the commission declined to outline which varieties of swaps would be subject to the new rules, much to the consternation of market players who sought clarity on the scope of the overhaul. On Wednesday, the commission said its definition would cover most known swaps while exempting insurance products and consumer transactions, like contracts to buy home heating oil.

The agency unveiled the definition jointly with the Securities and Exchange Commission, which shares oversight of the swaps market. The S.E.C. on Wednesday voted unanimously to propose the definition.

The commodity commission’s separate proposal to build capital cushions in the derivatives industry could help prevent a repeat of the 2008 financial collapse, regulators say.

In the lead-up to the crisis, investors bought billions of dollars’ worth of credit-default swaps as insurance on risky mortgage-backed securities. When the underlying mortgages soured, the American International Group and other companies that sold the swaps lacked the capital to honor their agreements.

Under the commission’s new plan, those firms would have to put aside enough cash to cover unforeseen calamities. Regulators, until recently, had little authority to set any rules for this risky market.

Still, there is no guarantee that enhanced capital levels would avert future disasters. And there is no magic capital number that regulators see as a cure-all; different firms will use different sorts of capital to satisfy the requirements.

Swap dealers and major trading firms that are already registered with the commission as futures brokers would have to hold at least $20 million in so-called adjusted net capital. Another set of firms would have to keep “tangible net equity” equal to $20 million. This standard would allow energy firms, for example, to count oil in the ground as part of their calculation.

Some argue that the requirement is too permissive.

“That insufficiently reduces risk,” said Dennis Kelleher, president of Better Markets. “Instead, the agency should consider a higher standard, such as liquid assets, to prevent another A.I.G. from happening again.”

The commission on Wednesday also voted to reopen or extend for 30 days the public comment period on its earlier rule proposals. The agency plans to complete most Dodd-Frank rules by the fall.

Article source: http://feeds.nytimes.com/click.phdo?i=3308ece8dfd047122a3ff34e2738ee0c