22 October 2013

Risk.net: Libor set to remain as benchmark rate for OTC derivative contracts

Given the pervasiveness of Libor as a benchmark in OTC transactions, a move to an alternative interest rate benchmark will face significant hurdles, said ISDA chief executive Robert Pickel.

While benchmark rates such as Libor may have originated in funding markets, the role of OTC derivatives and benchmarks in hedging funding exposure has put the use of Libor back in the spotlight given the recent manipulation of the benchmark by banks, said Pickel, speaking at the 2013 ISDA Asia-Pacific conference in Hong Kong.

However, a move to use other alternatives to Libor will ultimately be determined by the marketplace with significant legacy issues still to be addressed, and as a result the industry needs to develop a consensus on how to deal with legacy trades, Pickel said. "If you are able to develop a new benchmark that compares to Libor then you could discuss the basis on which you would transition legacy Libor contracts to the new benchmark. One of the issues of using the overnight indexed swap (OIS) rate, for example, is that it does not have a credit component whereas Libor does, so building in a credit component into the contract is still an issue", said Pickel.

Damien Scholefield, head of regulatory change, international and institutional banking at ANZ, backed Pickel's view on the importance of dealing with the legacy issue when transitioning to a new benchmark. "Libor is embedded in so many [derivative] transactions that it will continue to be an important benchmark. It is one thing to be comfortable with a new benchmark for new trades, but for existing trades to actually get to a stage where people are comfortable with agreeing to transfer to a new benchmark for legacy trades is many years away."

"It is likely that whatever new benchmarks that are agreed upon will need some form of adjustment mechanism for legacy trades. Given the long-term nature of the contracts that are tied to Libor you have to assume that there will be a continued need for Libor for a number of years", he said.

Panellists also advocated the benchmark reforms process undertaken by regional regulators such as Australia and Singapore in moving from a bank survey-based approach to a system based on benchmarks linked to tradable prices where possible and an enhanced governance structure for benchmarks that remain surveyed.

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