About the author - Randy Priem
Randy Priem is a finance professor at UBI Business School (Middlesex University London) and Antwerp Management School, where he teaches financial management, financial law, and FinTech courses. He is also a guest professor at the Katholieke Universiteit Leuven, where he obtained his PhD. In addition, he is the coordinator of the markets and post-trading unit at the Belgian Financial Services and Markets Authority (FSMA), where he supervises the Belgian trading venues, multilateral trading facilities, and central securities depositories....
As the official title of the Autocrat of all the Russias used to wrap up:
"....and so forth, and so forth, and so forth."
From the University of Chicago, Booth School of Business' Stigler Certer's ProMarket, October 9:
The financial market has moved from LIBOR to alternative interest-rate benchmarks, such as SOFR. Credit-sensitive rates, which are now becoming increasingly popular, carry greater risks than SOFR and other “risk-free rates” and must be used with great care. If not, United States legislators might need to step in to further stimulate the use of safter benchmark alternatives, writes Randy Priem.
Banks determine the interest rates, or interbank offered rates (IBORS), by which they borrow from one another. These benchmarks can be tethered to the demand and supply of different financial instruments, such as deposits, United States treasury bills, or commercial papers, which are short-term promises of repayment. In recent years, financial players have started to adopt credit-sensitive rates (CSRs), despite warnings from international finance organizations. Users should stick to alternative “risk-free rates” as much as possible or only use CSRs with great caution. If not, financial regulators might need to step in to protect markets against the shortcomings of CSRs and shift interest benchmarks to safer alternatives.
Banks have used IBORs since the late 1960s. These rates are set daily by a panel of banks, which provide the administrator of the benchmarks with data on transactions executed by them in the wholesale unsecured market, i.e. not secured by collateral (e.g. unsecured term deposits, commercial paper, certificates of deposits, and other short-term instruments). If no such eligible transactions are made, panels banks provide expert judgements based on real transactions in related markets, committed quotes, indicative quotes, or other market observations. The most popular of these IBORs was, until this year, the London Interbank Offered Rate (LIBOR). According to the Alternative Reference Rate Committee, it was estimated that the current outstanding contracts referencing USD LIBOR, including corporate loans, adjustable-rate mortgages, floating rate notes, securitized products and a wide range of derivative products, amounted to nearly $200 trillion in 2020, roughly equivalent to 10 times U.S. GDP.
However, in July 2017, Andrew Bailey, at the time chief executive officer of the United Kingdom’s financial regulator, raised serious concerns about LIBOR’s sustainability because it was not calculated based on submitted transactions from an active underlying market . Since the global financial crisis of 2007-2009, changes in bank regulation have led to a dramatic quantitative reduction in the volume of markets for wholesale funding deposits, commercial paper, and certificates of deposits, which have historically underpinned the IBORs, rendering them relatively inactive. If there is no incorporation of an active underlying market, it becomes challenging to establish a benchmark that accurately reflects financial movements, even if the IBOR administrator tries to use transaction data as much as possible instead of quotes or expert opinions. That is, in the case that a benchmark is based on a thin market with only a few transactions, panel banks can more easily steer or manipulate them, thereby influencing the resulting benchmark. Even more philosophically, if “something does not really exist,” how can it then be aggregated, reflected, and used by the market? Furthermore, there are financial stability risks if a benchmark is used in contracts worth trillions of dollars while only based on a very low volume of transactions (i.e. an inverse pyramid problem). As a consequence, the InterContinental Exchange (ICE) Benchmark Administration, which administers many of the world’s benchmarks, ceased all LIBOR settings by September 2024....
....MUCH MORE
