Former CFTC Head Talks LIBOR

The London Interbank Offer Rate (LIBOR) had a fatal flaw which led to its downfall, according to the former head of the Commodities Futures Trading Commission (CFTC).

Timothy Massad was the Chair of the CFTC from 2014-2017 and he joined Haime Workie who is FINRA’s Senior Director and Head of Financial Innovation in a FINRA webcast to talk about LIBOR.

During the webcast, Timothy Massad said this about LIBOR, “Even though it’s used for hundreds of trillions of dollars of contract there are very few transactions on which it is based. Today, there could be no transactions in a single day.”

He explained further that banks would quote the rate that it cost them to borrow from other banks. This was LIBOR. But, as Massad explained, banks borrowed less and less from each other until there were so few transactions upon which to base LIBOR that banks began to estimate. This made the rate easy to manipulate which is what happened with the LIBOR scandal.

The scandal brought all sorts of global reforms which Massad spoke about. Massad said some of the reforms by the CFTC included requiring a wall between those estimating LIBOR and traders and retaining documents for an audit trail.

“Greater transparency and integrity in the process basically,” he said. He noted further, “There were a series

of other reports done by the UK authorities as well as the Financial Stability Board as well as the IOSCO, the International Organization of Security Commissions, that came up with a very good package of reforms generally for benchmarks like this one and again those emphasized greater transparency, greater integrity in the process and the ability to really have an audit trail.”

Workie noted that LIBOR is slated to go away entirely in 2021 and Massad said that this is because LIBOR still has so few transactions that it remains an estimate. A new rate needed to be formed which had transaction determining its value. He said this was the goal of the Alternative Reference Rate Committee (ARRC) which was formed in 2014. ARRC created the Secured Overnight Financing Rate (SOFR) in 2017.

Massad noted that it fixed the fatal flaw, “that’s {SOFR} based on repurchase transactions.” “There are about $800 billion worth of those transactions each day,” Massad continued, “It’s a secured rate; LIBOR was unsecured. It is what we call a risk free rate because it does not include a credit element which LIBOR did and it’s an overnight rate; LIBOR was quoted in a number of tenors and maturities.”

SOFR is, “based on transactions in the Treasury repurchase market, where investors offer banks overnight loans backed by their bond assets,” according to Investopedia.

SOFR is not only a benchmark but a trading vehicle. For instance, the CME includes a SOFR future product to trade.

The CME notes on its website, “CME SOFR futures are the leading source of SOFR price discovery, trading alongside deeply liquid Eurodollar, Fed Fund and Treasury futures to offer seamless spread trading and unmatched capital efficiencies through margin offsets.”