The London Interbank Offered Rate (LIBOR) is the interest rate that banks charge each other to borrow short-term on the London interbank market. LIBOR is also the broader financial world's benchmark for setting short-term interest rates for products like variable-rate mortgages and corporate loans.
Since the time of its launch in 1986, the rate has been compiled and published by the British Bankers Association (BBA). However, after a manipulation scandal that implicated more than a dozen big banks shook investor confidence in the accuracy of the rate, a UK regulatory panel stripped the BBA of its role in setting LIBOR. In July 2013, it was announced that NYSE Euronext had won the contract to "administer and improve" the benchmark rate.
Its rate-setting mechanism invloves using a reference panel of bankers, who each submit a rate based on perceived fair value pricing. BBA would then compile the list and publishes the LIBOR rate at 11:00 am GMT daily. LIBOR loans are priced in Eurodollars - U.S. dollars in foreign hands - and can mature in as little as 24 hours. It is used as a reference rate for key financial products like interest rate swaps, short-term interest rate futures, credit default swaps and forex rates.
Futures and options contracts on the LIBOR are a key component of the CME Group interest rate products suite, and are especially attractive to fixed interest money managers looking to hedge their short-term interest rate risk. The CME lists 12 consecutive one-month LIBOR futures contracts that trade most actively near the quarterly expiration months of CME Eurodollar futures. More than 1.5 million LIBOR futures contracts trade daily on the CME.
In February 2012, more than a dozen traders and brokers in London and Asia lost their jobs, were suspended or were put on leave, as a result of a probe into the LIBOR system which alleged manipulation by major institutions, including Deutsche Bank, JPMorgan Chase, Royal Bank of Scotland and Citigroup. Inter-dealer broker Icap also suspended one employee and put two on administrative leave following the allegations. U.S. and UK regulators requested information from Icap, as well as two other major inter-dealer brokers, Tullett Prebon and RP Martin, hoping to uncover data regarding information sharing among brokers, hedge funds and banks.
The first fines related to the scandal were assessed in July 2012 to Barclays. The fines, which totaled about $440 million, were issued by the U.K. Financial Services Authority, the Commodity Futures Trading Commission and the U.S. Department of Justice.  UBS and the Royal Bank of Scotland (RBS) were also assessed fines in 2012. In January 2013, the International Organization of Securities Commissions issued a consultation and request for comment on changes to the regulation of financial benchmarks such as LIBOR. IOSCO expects to publish its recommendations by the middle of 2013.
The manipulation scandal dates back to the financial crisis of 2008 when, during this volatile period, numerous financial institutions were having difficulty obtaining short-term funding. Because LIBOR is set by member banks and involves individual submission of observed rates, rather than based on actual transactions, it was suggested that the daily rate fix is subject to manipulation. In the CFTC's charges against Barclays, the commission found that the bank "routinely made artificially low LIBOR submissions to protect Barclays’ reputation from negative market and media perceptions concerning Barclays’ financial condition."
In 2008, U.S. bankers and investors complained that the LIBOR rate remained higher than it should have been, and charged that the way it is calculated is somehow flawed. The rate spiked again in late April 2008 on news that the BBA was investigating whether banks had, in fact, been deliberately under-reporting the interbank rates they had been paying.
Some observers pointed to the widening spread between LIBOR and the overnight indexed swap (OIS) rate - an indicator of expected central bank interest rates - as evidence that LIBOR is too high. Others said credit fears are not the problem, since banks' credit-default swap (CDS) premiums had been falling. As a result, the Bank of England in April 2008 introduced a Special Liquidity Scheme allowing banks to swap asset-backed securities for 9-month treasury bills to raise liquidity in the LIBOR market.
- Not So Fast, Libor Manipulation Still A Threat Under NYSE Euronext Takeover. Forbes.
- NYSE EuroNext to Take Over Administration of Libor. New York Times Dealbook.
- BBA LIBOR - Frequently asked questions. BBA.
- CME LIBOR Futures. CME Group.
- Libor investigaton: traders fired and suspended - report. Telegraph.
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- Libor scandal: Seven banks face US questioning. BBC.
- IOSCO Consults on Financial Benchmarks. IOSCO.
- CFTC Orders Barclays to pay $200 Million Penalty for Attempted Manipulation of and False Reporting concerning LIBOR and Euribor Benchmark Interest Rates. CFTC.
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- Bankers' trust. The Economist.