A body set up by the US government to investigate reforms of how banks lend to one another has decided on a new benchmark rate to replace LIBOR – the gauge which was the subject of a huge price rigging scandal in recent years.
The Alternative Reference Rates Committee, or ARRC for short, on recommended on Thursday that banks start using a new broad Treasuries repo rate, which will work by reflecting how much it costs to borrow cash secured against US government debt, also known as Treasuries.
“At its meeting today, the Alternative Reference Rates Committee (ARRC) identified a broad Treasuries repo financing rate, which the Federal Reserve Bank of New York has proposed publishing in cooperation with the Office of Financial Research, as the rate that, in its consensus view, represents best practice for use in certain new U.S. dollar derivatives and other financial contracts,” a statement from the ARRC said.
The move was first suggested by regulators, who feared that the decline in short-term bank lending since the 2008 financial crisis had undermined faith in the use of LIBOR, and risked the future of trillions of dollars worth of US dollar denominated derivatives that were backed by LIBOR.
“The ARRC today took an important step to strengthen the financial system by selecting a robust alternative reference interest rate,” said Sandra O’Connor, chief regulatory affairs officer at JPMorgan and chair of the ARRC.
“I am proud of the committee’s work, and look forward to our continued efforts to promote the widespread adoption and use of this rate.”
The LIBOR manipulation scandal, which hit four years after the 2008 financial crisis, risked breaking trust in London’s ability to function as a financial centre.
LIBOR, a benchmark underpinning more than $300 trillion in loans and derivatives, was set by a panel of banks that submitted short-term borrowing rates to the British Bankers’ Association at the time of the scandal.
Regulators found that traders and rate-setters had colluded to shift the rate, benefiting the traders’ positions and leading to billions of pounds in fines from US and UK regulators. Libor has since been reformed, and is no longer compiled by the BBA.
The ARRC’s recommendation comes just under two months after a Bank of England recommended a new alternative to LIBOR for use in sterling derivatives. In April, a panel of banks, including the likes of Goldman Sachs, Barclays, and Deutsche Bank approved SONIA – which stands for the Sterling Overnight Index Average – as its preferred short-term interest rate benchmark.
The SONIA index tracks the rates of actual overnight funding deals on the wholesale money markets, rather than relying on submitters, and its use will minimise “opportunities for misconduct,” the Bank of England said at the time.