Libor Reforms

ICE Benchmark Administration (IBA), the new administrator of Libor has published a position paper on the future evolution of Libor. Following major reforms were proposed by the FSB on July 2014 for the major interest rate benchmark.

• Strengthening the existing IBORs and other potential reference rates based on unsecured bank funding costs by underpinning them to the greatest extent possible with transactions data (“IBOR+”)  
• Developing alternative, nearly risk-free reference rates (RFR) since FSB Members believe that certain financial transactions, including many derivatives transactions, are better suited to reference rates that are closer to risk-free.

Another concern was raised that reference rate should be based exclusively in actual transactions. But this can be applicable only  for the currencies or markets that have enough liquidity and actual transactions. When conditions in the local market do not allow pure transaction rates (ones derived mechanically from transacted data without use of expert judgement), authorities should work with and guide the private sector to promote rates which are derived on a waterfall of different data types: underlying market transactions first, then transactions in related markets, then committed quotes, and then indicative quotes.

IBA has proposed many reforms and it is expects the market participant's view by Dec 2014.Focus is on making the whole process including Libor definition , calculation methodologies used by individual banks, submitting Libor rates and selecting the final Libor rates, more objective and completely transparent.

I agree with Prof Jayanth that submitter should not do the interpolation for the missing points in the Libor calculation as this can be more efficiently done by the administrator.

Another important proposed change is to change the trimming of the top and bottom quartiles allows for the exclusion of outliers from the final calculation. This trimming methodology was benefited to counter manipulations. From this perspective, ‘topping and tailing’ may be less relevant in that it would adjust a rate that had already been calculated formulaically from observable and testable evidence. As mentioned in the position paper currently several alternatives of this approach are being evaluated. If this smoothing of submitted Libor rates gets hanged than it can have large impact on rate and on it's volatility.