ACT stresses the importance of LIBOR and EURIBOR to companies

London - 24 October 2011

The Association of Corporate Treasurers notes the current enquiries by authorities in Europe and the US concerning past submission of rates to index compilers.

Published and widely accepted measures of short-term market interest rates like LIBOR and EURIBOR are essential to the proper functioning of business. In March of 2011, the Financial Times estimated the value of transactions indexed to LIBOR alone at US $350 Tn[1].

Companies value the work put in by contributor banks day by day. The absence of these important tools would make efficient conduct of business more difficult and costly. We think it essential that banks active in the relevant markets be willing to input rates promptly and in good faith to maintain orderly availability of these composite rates.

The availability of compiled rates generally accepted as representative of the relevant market sector facilitates not only loan pricing, but the development of reliable derivative markets such as forwards, futures, swaps and options. These permit parties to access borrowing or investing markets more easily in the currencies they need and also to hedge interest rate exposures.

Trying to replace the existing rate compilations for use in new transactions would be difficult. It would be especially difficult for existing transactions, given the large numbers of individual actions to be agreed between the parties. Many outstanding transactions have initial maturities of years if not decades with rate availability necessary throughout.

Responsible, well conducted banks that are significant participants in the relevant markets should feel an obligation to the markets generally and to their own customers to contribute and to continue contributing rates to the compilers of rate indexes unless the bank withdraws from markets or loses market share significantly and is no longer representative of the market. It is important that banks contributing rates have appropriate internal compliance arrangements. The calculation of the indices from the input data by the compilers must be done with similar care.

Colin Tyler, Chief Executive of the Association of Corporate Treasurers, commented:
“LIBOR and EURIBOR are of great importance to users of financial markets such as non-financial businesses of all sizes. We expect banks active in relevant markets to contribute rates in good faith and with appropriate compliance processes. We appreciate the time and effort put in by the contributor banks to make LIBOR and EURIBOR possible.”

Compiled rates

LIBOR and EURIBOR rates are calculated by the compilers from rates input by banks participating in the relevant markets. LIBOR is calculated by Thomson Reuters on behalf of the British Bankers Association and EURIBOR by Thomson Reuters on behalf of the European Banking Federation.

Inputs to LIBOR and to EURIBOR are estimates based on observations in the money markets by banks that input their own estimates. For LIBOR the input is an estimate of the rate at which the contributing bank thinks it could itself borrow in volume for the period and currency concerned. For EURIBOR it is the rate at which the contributor estimates that a “prime bank” could borrow.

Prior to the introduction of the composite rates like LIBOR and EURIBOR, if estimates of a prevailing market rate of interest were contractually necessary, particular arrangements were made case by case. For example, as increasing competition made use of a bank’s own estimate of its costs commercially unacceptable[2] in pricing variable interest rate loans by banks, it was customary that the lenders and borrower would agree a panel of “reference banks” that would agree to contribute their estimate of the rates at which they could borrow. A particular calculation of the average of the particular panel for that particular transaction was then made.

This contract specificity became increasingly cumbersome as the volume of transactions increased. LIBOR and, later, EURIBOR were valuable tools in this regard and allowed the development of derivatives permitting companies to access more debt markets

[1] “Stakes are high in setting LIBOR”, Megan Murphy, Financial Times, March 25 2011 22:25

[2] It may be noted that in market sectors where competition is less effective, for example in lending to smaller or weaker companies, some banks are in 2011 seeking to revert to pricing loans over the bank’s own cost of funds as determined by the bank. This is because LIBOR, for example, is an average rate for the estimated costs of the major participants in a market sector. In the febrile markets following the financial crisis, weaker banks may pay a volatile premium above that average when they borrow. A bank’s seeking “own cost of funds” basis for pricing (other than at times of extreme market disruption) should be a clear indication of anticipated weakness by the bank.

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