Now is the time to transition away from the London interbank offered rate, the decades-old benchmark used to calculate the rate of interest charged on more than half of adjustable-rate U.S. home mortgages.
I say this for three reasons.
First, Libor is irredeemably tarnished. As former chairman of the Commodity Futures Trading Commission, I know how Libor was grossly manipulated to benefit loan and bond portfolios. The CFTC aggressively pursued and prosecuted many of these cases. The scandal drew headlines in the British press that were an embarrassment to the City, London’s financial service industry. Libor’s disrepute cannot be undone.
Second, Libor is a flawed and weak benchmark. As a former senior executive of an interdealer broker of over-the-counter swaps, I know that a benchmark’s resistance to manipulation derives from being built upon an underlying marketplace of both deep and broad participation. Libor is no longer drawn from active market activity, like benchmarks for most markets, but rather from daily polls of a small panel of large banks. As a result, Libor suffers from two shortcomings: shallowness of liquidity because of thin trading volume, and narrowness of liquidity because of its reliance on too few primary dealers. When it comes to manipulation, the second shortcoming may be worse than the first.
Third, Libor can be replaced readily with reliable alternatives that address its shortcomings of both breadth and depth of underlying liquidity. As an independent director of the American Financial Exchange, I believe that Ameribor is one of those alternatives.
Ameribor is the creation of the businessman, inventor and entrepreneur Richard Sandor, the AFX's chairman and chief executive. Ameribor was launched five years ago to serve the needs of small, medium-sized and regional banks across the U.S. that lend to the real economy of homebuilders, auto dealers and small manufacturers against collateral of mortgages, leases and plant and equipment. These community lenders, including critical minority-owned depository institutions, need a broad-based, unsecured interest rate benchmark that tracks their funding not secured by readily liquid Treasury securities. For many banks big and small, a credit-sensitive benchmark like Ameribor can play a crucial role in ensuring fair pricing on credit and increasing transparency and liquidity in unsecured debt.
Unlike Libor, Ameribor has well over 200 contributing banks. This breadth of market participation is important. It guards against manipulation and provides continuity during periods of stress. Ameribor is also verified by an independent audit to be compliant with the International Organization of Securities Commissions.
AFX members and Ameribor users are committed to the demise of Libor and replacing it as quickly as possible with qualified market-driven replacement benchmarks like Ameribor. That said, there are other sound alternatives.
The Secured Overnight Financing Rate, or SOFR, is a risk-free replacement rate for Libor that reflects larger banks’ secured funding costs. It has been recommended by the Alternative Reference Rates Committee and is preferred by large primary dealers of U.S. Treasury securities because it is built upon an underlying Treasury repo securities market of considerable depth. Undoubtedly, SOFR is a fully appropriate rate for the banks for which the Treasury repo market reflects their cost of funding.
In a lending market as broad and complex as that of the United States there is room for more than one responsible replacement for Libor. Most classes of tradable assets have a range of benchmarks. Equities are ranked by the Dow Jones, the S&P, the Russell and many other indexes. Oil is priced by a range of indexes, as are agriculture commodities like wheat and cotton. Only short-term and fixed-income lending has been so dependent for so long on a singular flawed index: Libor. Overreliance on a single benchmark is a lingering vulnerability in U.S. financial markets that should be avoided.
Anticipating Libor’s demise, America’s regional and local lenders need to be able to choose among qualified benchmarks that best enable them to fund their vital services to local businesses and retail customers. They must have certainty of choice among well-constructed benchmarks that meet U.S. and global regulatory standards and are based on market-driven trading on exchanges overseen by U.S. regulators.
I applaud congressional efforts to provide legal certainty to replace “tough legacy” Libor contracts. Passage of proposed Libor transition legislation is critical and should be done as quickly as possible to facilitate the smoothest and most expedited replacement of outstanding contracts referencing that irredeemable benchmark.
But any legislation addressing Libor should make clear Congress’s endorsement of choice of qualified interest rate benchmarks for all new obligations by America’s lending institutions, especially its regional and local banks and irreplaceable minority-owned depository institutions that support diverse communities. Official sector support for responsible choice will help spur these lenders to make the switch away from Libor and reduce the backlog of lingering Libor holdouts at the end of its life.
While Congress provides for a legally certain path for tough legacy Libor contracts to default to SOFR, it should also make clear that for new benchmark-linked contracts in a post-Libor age, institutions and their customers will face no restriction in choosing among qualified market-based benchmarks that properly align local and community lending institutions and their cost of funding.
The choice is clear: Libor is dead. Long live choice.
