Libor Reform Can’t Work

Libor reform, as envisioned by regulators, cannot work. Not because there are no imaginable alternative benchmarks, but because the structure under which they are expected to operate cannot work, argues Steve Wunsch.

As noted in my previous TabbFORUM posts, Libor reform, as envisioned by regulators, cannot work. Not because there are no imaginable alternative benchmarks, but because the structure under which they are expected to operate cannot work.

Going from a “manipulated” quote-based system to a transaction-based one, as regulators are demanding, effectively requires changing from a non-continuous call market structure to its opposite: a continuous market structure. Since the call market structure was critical to Libor’s success, its elimination will make it forever non-viable.

[Related: “Maybe Libor Replacement Will Just Fade Away”]

And as if that weren’t enough, similar reforms imagined in all the world’s major currency pairs are bound to run into the same problem.

According to a recent article in Markets Media (“European Benchmark Transition Faces Hurdle”):

“The low volume of cleared swaps based on Eonia, the euro overnight index average rate, may make it difficult to transition to a new risk-free interest rate based on actual transactions as required by regulators.

“Chris Barnes at derivatives analytics provider Clarus Financial Technology said on the firm’s blog: ‘The number of cleared Eonia swaps is surprisingly low, suggesting a transaction-based methodology will be ruled out.’ ”

Regulators should consider this problem as the source of their collapsing reforms before it is too late.

[Related: “New Year Update on the IBOR Replacements”]

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