Tuesday, April 22, 2008

Libor calls for softly, softly approach

(FT) The British Bankers’ Association has opened the door to “evolutionary changes” in how it calculates London Interbank Offered Rate Libor in response to growing criticism about the accuracy of the global benchmark for borrowing costs.

However, the BBA is wary of introducing a radical overhaul in case this would trigger fresh instability to the loan and derivatives world.

“An evolutionary change may be necessary we have convened a panel to consider this,” John Ewan, director of BBA Libor group, told the Financial Times. “However, changing the rate radically at a time like this would not be the best strategy.”

The comments come amid rising concern about the Libor rate. This benchmark is calculated each day by the BBA, based on quotes submitted from a panel of banks, for a spectrum of currencies across a range of maturities.

The rate has traditionally been considered a key barometer of financial stress and swings in Libor can have big economic implications since many loan and derivatives contracts are based on it. Lehman Brothers, for example, calculates that $620bn of US investment grade and $30bn of high yield floating rate corporate debt is tied to dollar Libor as well as $900bn in subprime mortgages. However, bankers fear the index has become distorted in recent months, particularly in dollar markets, because it is calculated according to banks’ perceived funding costs rather than actual trades. As a result, some bankers are calling for greater use of indices derived from actual market trades.

Julian Van Kan, a senior BNP Paribas banker and chairman of the Loan Managers Forum in London, said bankers should return to their old approach of taking loan quotes from dealer groups rather than relying on screen-based Libor rates.

“We need to look back at history to break the current deadlock,” Mr Van Kan said.
In another twist, Tradeweb, a trading platform, will today launch the first major electronic marketplace for trading cash deposits between banks and institutional investors a move that could potentially provide another way of calculating funding trends, other than the Libor rate.

However, many bankers believe it would be virtually impossible to move away from Libor, given the volume of outstanding derivatives contracts tied to the rate.

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