Replacing the LIBOR with a Transparent and Reliable Index

Our LIBOR Reform Articles describe the main problems with the current LIBOR setting, put forward a proposal on how to reform LIBOR through a committed quote system (“CLIBOR”), and explain why the final Wheatley Review proposal on how to reform LIBOR, and its reasons for stopping short of our proposals, are not satisfactory for putting LIBOR on solid ground.

We have developed an alternative process of providing and disseminating reliable information on interbank lending and borrowing that we call “Committed LIBOR” or “CLIBOR.” We submitted this to the Wheatley Review for its consideration. The new process would stand on three pillars: Commitment, Transparency, and Governance.

1. Always Committed: CLIBOR requires participating banks to submit committed bids and ask quotes for interbank lending. Any transactions which occur after that submission (and before the next submission) must be at rates no higher than the submitted ask quote and no lower than the submitted bid quote. A penalty would be paid for any transaction that occurs outside the submitted bid-ask range, unless such transaction can be justified by the bank.

2. Transaction-Based: Where possible, banks above a certain size are required to report their interbank borrowing and lending transactions to a data-clearing house similar to the TRACE system that has been established for corporate bonds in the United States. This would increase substantially the number of banks for which reliable transaction-based data are available and provide not only a source for verification of the committed bids and asks, but also a (one-day lagged) alternative benchmark of interbank borrowing rates.

3. Independent Governance: It is necessary to establish a governance body for the data clearing and interbank lending rate reporting operations that would consist of representatives of banks, private parties that have a stake in LIBOR, and perhaps academics or other independent parties. Through a public bid, this CLIBOR governance body would select an organization to manage the data clearing house and CLIBOR rate setting process and dissemination. This selected organization would publish the daily interbank lending rates for relevant maturities and currencies, verify that each bank transacts consistently with its own quoted asks and bids, determine and collect penalties as needed, and address any banks that had an excessive frequency of penalties. It would also develop algorithms for calculating the CLIBOR in ways that would minimize the opportunity for abuse and regularly employ screening methods for detecting collusion and manipulation.

The CLIBOR process would cost somewhat more than the current LIBOR process. But it would result in an interbank borrowing rate that would be more accurate than LIBOR, restore the credibility of the process for setting an interbank borrowing rate, and reduce the incentives and opportunities for manipulating the rate by individual banks or through collusion. Importantly, it would ensure continuity with the existing LIBOR and minimize the transaction costs of replacing the index altogether.

The full papers are available for download here and here.