London Interbank Offered Rate Research Articles

Regulating financial benchmarks by ‘Proprietization’: a critical discussion

The integrity of price-related financial benchmarks such as the London Inter-bank Offered Rate (LIBOR) and the foreign exchange London WM Reuters 4pm ‘fix’ has suffered in the wake of revelations of manipulative activity carried out by individuals in financial institutions. A regulatory regime has since 2013 been introduced in the UK to oversee LIBOR, and more comprehensive thinking has been developing in relation to regulating financial benchmarks in general.1 This article argues that the regulation of financial benchmarks is very much caught between the desire on policy-makers’ part to preserve market stability, and yet maintain the nature of the financial benchmark as a market good. In the immediate aftermath of benchmark manipulation revelations, it is clear that regulatory response is needed. However, as will be discussed, policy-makers wished to avoid excessive intervention that would ‘publicise’ important benchmarks, and yet create a regulatory regime that would assure of the credibility of financial benchmarks that are produced by the private sector. The ultimate approach taken in the UK legislation is premised upon preserving hitherto trusted benchmarks by allowing them to become ‘proprietised’. These premises also underlie the international framework developed by IOSCO and the European approaches. The ‘proprietisation’ approach essentially allows designated entities to have exclusive rights to develop and exploit the financial benchmark in return for protecting its quality. This is a marketbased approach which preserves hitherto important financial benchmarks, but such preservation is achieved at the price of destroying the original characteristics of the benchmarks. The article fleshes out the features of the UK, EU and IOSCO regulatory regimes that reflect the proprietisation approach and critically engages in its benefits and drawbacks. We argue that the proprietisation approach, heavily underscored by regulatory subsidy, neither delivers optimal characteristics of market-based governance nor effectively addresses key regulatory objectives. We offer some suggestions as to adjustments to the current regulatory frameworks.

LIBOR troubles: Anomalous movements detection based on maximum entropy

According to the definition of the London Interbank Offered Rate (LIBOR), contributing banks should give fair estimates of their own borrowing costs in the interbank market. Between 2007 and 2009, several banks made inappropriate submissions of LIBOR, sometimes motivated by profit-seeking from their trading positions. In 2012, several newspapers’ articles began to cast doubt on LIBOR integrity, leading surveillance authorities to conduct investigations on banks’ behavior. Such procedures resulted in severe fines imposed to involved banks, who recognized their financial inappropriate conduct. In this paper, we uncover such unfair behavior by using a forecasting method based on the Maximum Entropy principle. Our results are robust against changes in parameter settings and could be of great help for market surveillance.

Long-Run Determinants of Equity Foreign Portfolio Investment (EFPI) in Sri Lanka: A Time Series Analysis with Autoregressive Distributive Lag (ARDL) Approach

Equity Foreign Portfolio Investment (EFPI) is useful in enhancing the efficiency and liquidity of capital markets. This study explores the long-run determinants of EFPI in Sri Lanka using the autoregressive distributed lagged (ARDL) model. The dataset covers monthly time series data from 2004 to 2013. The findings suggest that the London Inter-Bank Offered Rates (LIBOR), foreign reserves presented in months of imports, USD/LKR exchange rate and domestic share market performance measured by the All Share Price Index (ASPI) are statistically significant and have a long-run positive effect on EFPI. The remaining variables, three-month Treasury bill rates, the Colombo Consumer Price Index (CCPI) and the S&P500 index are statistically insignificant. It is further revealed that there is a short-run causality running from months of imports, three month Treasury bill rates, USD/LKR exchange rates and CCPI towards EFPI at the Colombo Stock Exchange (CSE).

Rational multi-curve models with counterparty-risk valuation adjustments

We develop a multi-curve term structure set-up in which the modelling ingredients are expressed by rational functionals of Markov processes. We calibrate to London Interbank Offer Rate swaptions data and show that a rational two-factor log-normal multi-curve model is sufficient to match market data with accuracy. We elucidate the relationship between the models developed and calibrated under a risk-neutral measure and their consistent equivalence class under the real-world probability measure . The consistent -pricing models are applied to compute the risk exposures which may be required to comply with regulatory obligations. In order to compute counterparty-risk valuation adjustments, such as credit valuation adjustment, we show how default intensity processes with rational form can be derived. We flesh out our study by applying the results to a basis swap contract.

Linearized Hamiltonian of the LIBOR market model: analytical and empirical results

ABSTRACTThe linearized Hamiltonian model is proposed to extend the London Interbank Offered Rate (LIBOR) Market Model (LMM). Firstly, we studied the Hamiltonian of LMM in the framework of quantum finance, and the nontrivial upper triangle form of LIBOR drift is derived. The linearized Hamiltonian is derived to improve the explanatory capability of the model for market data. Our approach uses one more parameter to explain the initial condition and the model can be used to calibrate LIBORs with extremely high accuracy. Furthermore, the market time index is required for applying the model to multi-LIBOR, and the results imply that the LIBOR future time lattice becomes shorter as one goes from near future to distant future.

Evolving financial benchmarks: The impact on legacy contracts

Following scandals surrounding alleged manipulation of the London Interbank Offered Rate (LIBOR) and the Euro Interbank Offered Rate (EURIBOR), the attention of market participants and regulators alike has turned to the question of whether financial benchmarks and the regulatory regime that governs them are still fit for purpose. This paper summarises key regulatory developments designed to address the perceived weaknesses of European benchmarks and considers the future of such benchmarks as reference rates in standard form contracts. It asks whether the current regulatory reform programme can accommodate the demands of its objectives, on the one hand, and the necessity of guaranteeing contractual continuity on the other. The paper concludes that, despite significant risks, there are reasons to believe the reform programme will successfully address the existing shortcomings without major disruption to existing contracts.

Drivers of intraregional M&As within developing Asia

A large part of the upsurge in global Foreign Direct Investment (FDI) until the global financial crisis of 2008–2009 has been due to mergers and acquisitions (M&As) as opposed to Greenfield FDI. Also, noteworthy is the growing significance of developing Asia in these cross-border M&As, both as sources of finance as well as destinations of investments. These cross-border M&A flows have deepened the economic integration of developing Asia with the global economy. This paper examines the extent and determinants of M&As to and from developing Asia over the period 2000–2010 with particular emphasis on the financial drivers of intraregional M&As. Global liquidity and risk conditions, as proxied by London Inter Bank Offered Rate (LIBOR), consistently show up as being an important driver of intraregional flows.

On arbitration, arbitrage and arbitrariness in financial markets and their governance: unpacking LIBOR and the LIBOR scandal

Amongst a series of scandals to hit international financial markets in recent years, that surrounding the London Interbank Offered Rate (LIBOR) – a highly influential interest rate benchmark – has attracted particularly intense media scrutiny. This paper seeks to push beyond conventional understandings to unpack critically both LIBOR itself and the scandal involving its manipulation by major international banks. Envisioning LIBOR as a commodity beset by inherent contradictions, the paper mobilizes the tropes of arbitration, arbitrage and arbitrariness to illuminate, respectively: the market-making work performed by LIBOR; its role in enabling the transfer of financial risk, most notably when fraudulently manipulated; and the nature of the regulatory prosecution of such manipulation.

A comparison of the information in the LIBOR and CMT term structures of interest rates

Abstract We investigate the information contained in the London Interbank Offered Rate (LIBOR) and the U.S. Constant Maturity Treasury (CMT) term structure of interest rates and report three novel findings. First, we document that the information contained in term structures are significantly different from one another. Second, we provide evidence of a significant change in the nature of this difference as the financial crisis began. Third, we find that the significant changes in the information content of CMT and LIBOR are consistent with significant shocks to credit default swap rates and tenor swap rates.

Too LIBOR, Too Late: Time to Move to a Market Rate

Barclays has been fined, the British have issued their report, and now the market is anxious for everything to go on as usual with the London Interbank Offer Rate (“LIBOR”). I think that would be a serious mistake. The U.S. and British investigations into rate-fixing by Barclays revealed a widespread culture of pervasive, deceitful conduct in the setting of the most important private sector benchmark for over $300 trillion in derivative contracts and $10 trillion in adjustable-rate loans. It is highly unlikely that Barclays was the only major bank engaging in this conduct, and public investigations and private lawsuits against a range of participants in LIBOR rate-setting are likely to reveal further misconduct in the months ahead. The basic structure for the setting of LIBOR is fundamentally flawed. It permits banks with obvious conflicts of interest to skew the LIBOR rate in order to benefit their own firm. Barclays, for example, was alleged to have attempted to manipulate LIBOR to benefit its traders and to hide its growing costs of borrowing in the financial crisis. The LIBOR structure also facilitates collusion among the rate-setting banks, in violation of the antitrust laws. Barclays, for example, was alleged to have attempted to manipulate LIBOR in collusion with other firms to benefit particular trades over a number of years. Both public antitrust investigations and a range of private lawsuits are likely to be pursued with vigor in the coming months. The collusion and manipulation were alleged to have occurred during both quiescent markets and turbulent ones. That is, the attempted manipulation of LIBOR was apparently not confined to one extraordinary “once-in-a-lifetime” financial crisis, when extreme market pressures might have lured firms to engage in this unlawful conduct, but rather was ingrained in the regular setting of rates. As it currently stands, LIBOR is not a market interest rate. It provides the illusion of market rates that are relied upon by everyone from sophisticated derivative traders to ordinary mortgage borrowers, but the rate itself is pure fiction. Banks submit a rate at which they supposedly could borrow, but there’s no requirement that the rates submitted be based on actual transactions. As Mervyn King, Governor of the Bank of England put it, LIBOR represents “the rate at which banks do not lend to each other.”

Testing uncovered interest rate parity using LIBOR

We test uncovered interest rate parity (UIP) using London InterBank Offered Rate (LIBOR) interest rates for a wide range of maturities. In contrast to other markets, LIBOR markets have minimal frictions. Whereas most previous studies reject UIP, we find that UIP holds for several short-term LIBOR maturities using block bootstrap panel unit root tests suggested by Palm et al. (2011) and cointegration techniques by Westerlund (2007). Furthermore, the estimation results suggest that the speed of adjustment to the long-run equilibrium marginally differs across the maturity of the underlying instrument, thus supporting the efficient market hypothesis.

Corporate governance in banks – A view through the LIBOR lens

Misreporting of borrowing rates by large banks and the resulting manipulation of London Interbank Offered Rate (LIBOR) has been the subject of headlines news recently. Confronted with charges from regulators, several banks, such as Barclays, UBS (originally Union Bank of Switzerland) and the Royal Bank of Scotland, have paid huge fines and settled the matter to avoid criminal prosecution. The scandal raises serious questions of corporate governance, and this article examines the issue from the governance perspective, using Barclays as a case study. Internal failures occurred at several levels in Barclays’ reporting of rates. Misreporting was mainly of two varieties – misreporting for personal gain and misreporting encouraged by senior managers, ostensibly in the corporate interests. The article argues that corporate governance systems and structures are powerless in dealing with such fraud or lack of judgment. Misreporting for personal benefit was clearly a breach of the fiduciary duty of loyalty of the managers involved. But misreporting, ostensibly to protect corporate interests, is more probably a breach of the emerging fiduciary duty of good faith. The article also points out that the misdeeds occurred in the banks during an era of financial liberalization and permissiveness. In particular, it highlights that the loose structure of interest derivatives and the potential they offered for speculation were important factors in the practices at the banks involved in the LIBOR episode. The article concludes with an analysis of the implications of the LIBOR episode and its consequences for corporate responsibility and accountability as well as public regulation and its efficacy.

Elaboration of Regulation in Consequence of the LIBOR Manipulations

Not long ago periodicals specializing in the field of law and finance revealed some details of fraudulent actions connected with the London Inter-Bank Offered Rate (LIBOR). In a certain moment it seemed that the scandal with LIBOR manipulations would not lead to any serious reforms, including those of the legal nature, and the outcome would be limited to separate sanctions against several large European and American banks. However, the European Union in full conformity with the purposes of its financial services policy has drafted new regulatory acts which will come into force in the near future and will allow combating more efficiently with various kinds of market abuse.

LIBOR as a Keynesian Beauty Contest: A Process of Endogenous Deception

This paper uses the Keynesian Beauty Contest as a theoretical framework to analyse the London Interbank Offered Rate (LIBOR) fixing mechanism, where the actual money market rate is seen as a fundamental value towards which the LIBOR should aim. By treating the LIBOR as the outcome of a particular kind of p-beauty contest game, in which players (LIBOR banks) are guided by higher order beliefs, a process is created whereby they are not solely dependent on their own incentives and constraints. Instead, potential deception is generated endogenously though the fixing process itself, resulting in systematic deviations of the LIBOR from its fundamental value.

LIBOR: Origins, Economics, Crisis, Scandal, and Reform

The London Interbank Offered Rate (LIBOR) is a widely used indicator of funding conditions in the interbank market. As of 2013, LIBOR underpins more than $300 trillion of financial contracts, including swaps and futures, in addition to trillions more in variable-rate mortgage and student loans. LIBOR's volatile behavior during the financial crisis provoked questions surrounding its credibility. Ongoing regulatory investigations have uncovered misconduct by a number of financial institutions. Policymakers across the globe now face the task of reforming LIBOR in the aftermath of the scandal and crisis.

Dependence structure between LIBOR rates by copula method

This paper discusses the correlation structure between London Interbank Offered Rates (LIBOR) by using the copula function. We start from one simplified model of A. Brace, D. Gatarek, and M. Musiela (1997) and find out that the copula function between two LIBOR rates can be expressed as a sum of an infinite series, where the main term is a distribution function with Gaussian copula. Partial differential equation method is used for deriving the copula expansion. Numerical results show that the copula of the LIBOR rates and Gaussian copula are very close in the central region and differ in the tail, and the Gaussian copula approximation to the copula function between the LIBOR rates provides satisfying results in the normal situation.

A Comparison of the Information in the LIBOR and CMT Term Structures of Interest Rates

We investigate the information contained in the London Interbank Offered Rate (LIBOR) and the U.S. Constant Maturity Treasury (CMT) term structure of interest rates and report two novel findings. First, we document that the information contained in terms structures are significantly different from one another. Second, we provide evidence of a significant change in the nature of this difference as the financial crisis began in 2007, a period over which there is alleged collusive behavior in LIBOR settings.

Detection of manipulation of inter-bank overnight rate using Euclidean-based time series cluster analysis

The interbank offered rate (IBOR) is the interest rate at which banks can borrow funds from other banks in the interbank market. It is also used as the benchmark upon which rates or financial contracts for less preferred borrowers are based. In light of the recent London IBOR (LIBOR) manipulation incident, this paper seeks to address the concern that IBOR is entirely controlled by the banks. The paper focuses on the comparison between LIBOR and Singapore IBOR (SIBOR) especially with regards to the behaviour of the interest rate with time. The nature of IBORs is such that the rates submitted by the banks will naturally be similar and should not differ excessively from the market as well as the other banks. We will compare the LIBOR and SIBOR from 2005 to 2011 with respect to the one-month rates on an annual basis. The results of our study support that the SIBOR is not manipulated like LIBOR.

The Role of Ethics in the Anglo-Saxon Financial System

The current process of the globalization of finance has showed significant questions related to the behaviour of market participants and to the ethical dimension of business operations, particularly in the Anglo-Saxon financial system. In this context, the recent banking and corporate scandals (such as, for example, the collapse of Northern Rock, Lehman Brothers and the manipulation of the London Interbank Offered Rate – LIBOR) revealed the problematic relationship between some financiers and ethics. This paper attempts to argue that the Anglo-Saxon financial market is centred on an attention to increase in profit, an objective which comes under a regulatory framework marked by the adoption of “principles-based” schemes and forms of self-regulation. For this reason there is a need to give particular attention to the proper functioning of financial relationships, with a view to safeguarding the interests of all actors who operate in the market. As a result, the achievement of acceptable levels of ethics depends on “prudent management” and, therefore, on the ability of intermediaries to pursue operational conducts based on fairness and transparency.

LIBOR Manipulation Empirical Analysis of Financial Market Benchmarks Using Benford's Law

The London inter-bank offered rate (LIBOR) serves as a benchmark for many financial transactions worldwide today. These rates have been subject to manipulative conduct, false reporting and collusion. In forensic accounting, the Benford test has been implemented to successfully detect manipulated data. In this paper, we develop an approach to enable the application of the Benford method to LIBOR and other financial market benchmarks. The test results for all 150 LIBOR rates show a concentration of notably high deviations from the Benford distribution in single periods and currencies. Moreover, we find that the LIBOR quotes deviate much more than the banks’ credit default swap spreads. We conclude that all banks are presumably involved in the submission of manipulated data. Furthermore, we show that other financial benchmarks are worthy of closer scrutiny.