Has Andrew bailey been lying all along?

Our intention is that, at the end of this period, it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR.  It would therefore no longer be necessary for us to sustain the benchmark through our influence or legal powers.

Andrew Bailey, July 2017, The future of LIBOR
The FCA welcomes the Government’s announcement today that it intends to bring forward legislation to amend the Benchmarks Regulation (BMR) to give the FCA enhanced powers.



Those two statements from the same institution, just a couple of years apart, should be testimony that it has never really understood the game it was playing with LIBOR (and fire). LIBOR is not, will not and has never been perfect. But because of history, in which regulators, in particular the Bank of England, has played a significant role, transitioning from LIBOR is more difficult than creating a world without LIBOR if LIBOR had never existed. It is difficult to have a coherent plan when your regulator and the governor of the Bank of England are schizophrenic about what should be done.

A premonitive blog of mine, from February 2017, was titled Change of benchmark index is a difficult task. To be fair, I exaggerate a little bit my premonition superpower, the real title was Change of benchmark overnight index is a difficult task. I will be able to use that premonitive title again soon in relation to EFFR/SOFR transition, but this is another blog (and another seminar). The point is that changing benchmark is more difficult than creating a benchmark where none existed.

All the solutions presented by regulators and ISDA are about legal issues, not about why we have the LIBOR king in the first place. That reason is risk management. Having a fallback in place or a super-powerful FCA is not helping risk management, it is only helping legalese discussion on the transition. My understanding of what FCA is trying to do is to forbid the use of LIBOR for interbank derivatives but forcing the use of LIBOR when it cannot be changed. The forbidding of interbank use is through unreviewable unrepresentativeness declaration and blackmail about "serious questions". This dichotomy between tough and not-so-tough legacy trades has a name in quant speak: unhedgeable basis. Unhedgeable means no replication, no risk free valuation, including market price of risk in pricing, and higher cost for end users.

From my quant perspective, those recent decisions by regulator, maybe with the help of unsuspecting parliamentarians, is simply an additional cost for interest rate risk management, i.e. increased financing cost for corporates and increased mortgage cost for house owners. The only winners: benchmark interest rate quants, e.g. me! So much more potential work, so much more crazy pricing adjustments, like Value Adjustment for Transition (VAT). I certainly have to recognize my conflict of interest in that matter!

As usual, don't hesitate to contact me if I can help (for a reasonable fee) in navigating this schizophrenia.

Note: I have a mathematical doctorate, not a medical doctorate. My use of the term schizophrenia should not be understood in the psychiatric sense but in the general use sense of "approach characterized by inconsistent or contradictory elements".

Comments

Post a Comment

Popular posts from this blog

Multi-curve framework book: new edition in progress

Image
Subject: Interest Rate Modelling in the Multi-curve Framework: Foundations, Evolution, and Implementation It has been more than 10 years since I wrote the first edition of the multi-curve framework book. What happened in those 10 years? Why did it take me so long to start a new version? It took me roughly 10 years to write the first edition. The reason it took so long at that time, was that I did not know that I was writing it! I thought I was writing a couple of pages on an obscured and theoretical idea that there was not a `` one curve to rule them all '' but multiple curves. It turned out that it became the actual practice for very clear and important reasons. That was the excuse for the first edition, what is the excuse for the second edition? Since the first edition, many things happen, in particular: March 2015: BCBS - IOSCO: margin requirements for non-centrally cleared derivatives and mandatory variation margin July 2017: The future of LIBOR -- actually it...
Read more

Rigged: part 1 - Will there be a part 2?

Image
I have been reading book “Rigged: The Incredible True Story of the Whistleblowers Jailed after Exposing the Rotten Heart of the Financial” (Andy Verity, Flint, June 2023) for some time. It was published several month ago, but I just finished it. To my defence, I have to say that I don’t feel comfortable reading fiction where the “bad guys” are systematically winning by cheating. The book is the story of the miscarriage of justice done in the LIBOR manipulation story. The book content did not surprise me. For anybody having worked on a (swap) trading desk, it is clear that what was described by the accusation was impossible. It is not possible for some middle level trader to create a multi-year, multi-desk, multi-bank international conspiracy over open lines, broker lines, on open offices etc. without all around them, including compliance and senior management to be fully aware of what is going on. Moreover the regulators cannot be ignorant of the situation, except pleading complete in...
Read more

Treasury / Swap spreads are negative. And what?

In recent weeks there were several news articles related to the negative treasury/Swap spread. This is in particular the case of a Bloomberg article and a Zero Hedge blog . Some of the “information” in those notes are Swap rates are what companies, investors and traders pay to exchange fixed interest payments for floating ones. That rate falling below Treasury yields […]  is illogical in the eyes of most market observers, because it theoretically signals that traders view the credit of banks as superior to that of the U.S. government. It’s hard to overstate how illogical it is when swap spreads are inverted. That’s because it suggests that governments are less creditworthy than the very financial institutions they bailed out during the credit crisis just seven years ago. Let’s be clear, to me, those claims are purely wrong , nothing is “ illogical ” in negative swap spread. But why do I rant about that in the “multi-curve framework” blog? Because it is exactly the same that ...
Read more