Issue: September 2012 / November 2012
Editorials

INTEREST-RATE FIX

Lies and LIBOR

Trustees of SA pension funds should understand what happened, if only to offer comfort in the unlikely event that they’re similarly affected by a rate-fixing scandal. Trevor Abromowitz explains all, including the difference from our own JIBAR


Abromowitz...SA transparency
LIBOR stands for the London Interbank Offered Rate. Widely regarded as the most important interest rate in finance, it’s the benchmark interest rate on about $800 trillion worth of financial instruments ranging from complex derivatives to simple mortgages.

It is calculated by taking estimates at 11h00 in London from a panel of 18 banks of what they think that they will pay to borrow should they need to borrow money on that day. The top four and bottom four estimates are discarded and LIBOR is calculated as the average of the 10 remaining banks.

Barclays, the multinational banking and financial services group, is at the centre of the LIBOR-fixing scandal. Two major issues are its manipulation of LIBOR and the manipulation of its own LIBOR submission.

LIBOR manipulation

From the way that LIBOR is calculated, it’s a mathematical impossibility for Barclays to have manipulated LIBOR on its own. Barclays would have had to be colluding with at least four other banks in order to have an impact on the LIBOR calculation. Regulators around the world are questioning, and in certain cases investigating, some of the world’s biggest banks for possible collusion.

If evidence is found, it will further blight the reputation of the banking industry. Even more concerning for banks is the extent of liability that they may consequently face should the regulators require them to pay compensation.

Liabilities might be so large that guilty banks could need further bailouts. This is referred to as the banking industry’s “tobacco moment”, comparable to the settlements that cost the tobacco industry more than $200bn in 1998.

Barclays’ LIBOR submission

Before the 2008 sub-prime crisis, banks’ LIBOR submissions fell in a narrow band. But after the collapse of Lehman Brothers, banks became hesitant to lend to one another. The LIBOR rate rose and the dispersion of LIBOR submissions by the participating banks widened (see table). A higher rate reflects higher risk; a bank would need a higher reward for lending money to another bank with higher risk.

In the period after Lehman, Barclays’ LIBOR submissions were the highest of the 18 participating banks. As a result, Barclays decided to lower its LIBOR submission so that it was more in line with the other banks. This was possible since LIBOR is merely an estimate of the rate that banks think that they will need to borrow.

The rationale was that a lowered submission would make Barclays seem less risky than it actually was, and thus serve to calm markets. The extent to which the Bank of England knew about, and approved, Barclays’ LIBOR submissions was put into dispute when then Barclays chief executive Bob Diamond gave evidence to a UK parliamentary inquiry.

The SA equivalent, JIBAR

JIBAR stands for the Johannesburg Interbank Acceptance Rate. It is calculated by taking the submissions of nine particpating banks at 11h00 each working day, discarding the two highest and two lowest submissions and then averaging the remaining submissions. Each participating bank must submit a bid and offer rate. Each bank’s submission is calculated as the mid-point of the two.

Importantly, the bid and offer rates are based on tradeable instruments (called Negotiable Certificates of Deposit) issued by the respective banks. They aren’t estimates. The calculation of JIBAR is also transparent in that the rates of the particpating banks are published on Reuters and Bloombergs (see graph as an example).


Click to enlarge


Source: JSE

Notes: JSE calculates five different JIBAR rates – for terms of 1, 3, 6, 9 and 12 months

It’s evident that the calculation of JIBAR is more reliable than the calculation of LIBOR. Also, last year the SA Reserve Bank (SARB) initiated a review of the processes and procedures around the determination of domestic money-market rates including JIBAR. According to the SARB’s website, the review is expected for completion by end-August.

This is important for SA retirement funds that could have direct JIBAR exposure. Exposure could take the form of Negotiable Certificates of Deposit (where funds earn JIBAR) or floating-rate notes (where funds receive JIBAR-linked coupons).

Retirement funds could have interest-rate swap exposure where they may pay the difference between an agreed fixed rate and JIBAR. The look-through principle contained in new Regulation 28 gives trustees the ability to understand their retirement fund’s underlying holdings and the extent to which the fund has JIBAR exposure.

Mark Twain popularised the phrase, “Lies, damned lies and statistics” to describe the persuasive powers of numbers. Benchmark interest rates are powerful numbers. They should not be open to persuasion or manipulation and should certainly not be associated with lying.

Abromowitz is head of institutional
business at OMIGSA liability-driven investments.