For example, the Euribor (Euro Interbank Offered Rate), which is calculated in a similar way to LIBOR and is therefore also susceptible to manipulation, will in future only be determined for the most common tenors. This is based on recommendations made in January 2013 by the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) to the European Banking Federation (EBF) (see BaFin Journal, issue February 2012). Moreover, since 1 June 2013, banks that participate in determining the EONIA (Euro Overnight Index Average) no longer have to participate in determining Euribor. At the beginning of the year, EBA and ESMA also issued recommendations to the national banking supervisors relating to the supervision of credit institutions represented on the Euribor panel; the recommendations are largely in line with the German Minimum Requirements for Risk Management (Mindestanforderungen an das Risikomanagement der Banken – MaRisk).

Principles for setting benchmarks

At the beginning of June, the two European supervisory authorities also published principles for benchmark-setting processes that are binding on banks and insurers. The aim is to make the benchmarks less susceptible to manipulation and more representative and transparent. The principles cover the entire process, from the provision of data to the publication and use of the benchmarks. They apply not only to interbank interest rates, but also to indices and prices of other products such as equities, commodities, currencies and derivatives. They require that benchmarks should as far as possible be derived from actual transactions. The European Commission is also planning to make manipulation of benchmarks a criminal offence by extending the scope of the Market Abuse Directive. It is also planning to present a proposal for a regulation on benchmarks.

At the global level – in parallel with the EBA and ESMA – the International Organisation of Securities Commissions (IOSCO) is also currently developing principles for benchmark-setting processes. The work is close to completion. Reference interest rates are also a topic for discussion in the Financial Stability Board (FSB), which has announced that it will set up a working group tasked with, among other things, ensuring that newly developed benchmarks comply with international standards.

Interview with Dr Elke König

BaFin President: “Replacing Euribor and LIBOR”

Dr König, what do you think of the moves by European and global authorities and bodies to regulate reference interest rates?

The activities that have been performed and launched to date are by and large the right ones, but simply revising the rules for the Euribor and the LIBOR is not enough. Our ultimate goal has to be to find alternatives to these reference interest rates. The global financial system cannot afford to work with benchmarks that are largely based on estimates. That is a design flaw that is impossible to correct, no matter how good your governance is.
Why aren’t they replaced straight away? Why go to all the trouble of introducing new rules for the old systems?
Of course I’d prefer such a solution, too. But the fact remains that Euribor and LIBOR are major, important benchmarks and many products are based on them. We can’t just abolish these benchmarks from one day to the next; we have to ensure an orderly transition. That isn’t entirely easy, but we are making progress: the search for suitable alternatives has already begun – that is to say for benchmarks that are based directly on observable transactions entered into on liquid markets. We will continue to drive activities on this issue forward. Nevertheless, we should be clear about one thing: it is primarily the responsibility of the private sector to ensure that the Euribor/LIBOR saga is brought to a speedy conclusion. Anyone who enters into contracts based on LIBOR, Euribor, or similar benchmarks today does so in the full knowledge of their weak points.

What about EONIA, which is an important benchmark for pricing very short-term unsecured money market transactions?

No, EONIA isn’t part of the problem. There’s a crucial difference: EONIA is calculated by the European Central Bank on the basis of actual interbank transactions. This is not the case with Euribor and LIBOR. However, in the past, banks could only participate in EONIA if they also participated in Euribor. That was extremely unfortunate from our point of view, which is why we called for the two panels to be separated. Encouragingly, the European Banking Federation (EBF) took our views on board at the end of May.

At the start of the interview you said you agreed “by and large” with the regulatory steps taken so far. What’s the problem in your view?

Problem isn’t quite the right word. It’s more that the devil is in the details – although they are very important ones. The risk management recommendations issued by EBA and ESMA are in line with what we expect from banks anyway. But – unlike EBA – we believe it’s a matter for individual banks alone to decide whether they want to be involved in setting a private-sector benchmark. We won’t put any pressure on institutions to do so.

I also welcome the principles for setting benchmarks drawn up by EBA and ESMA. They are an important step in a direction that BaFin had wanted to take right from the beginning – towards benchmarks that are based on transactions that have actually been entered into. Here I believe that the private sector clearly also has a responsibility. The big but is that only banks and insurers have to comply with these principles. This means that supervisors such as ourselves can only appeal to banking associations, stock exchanges and other players to adhere to them as well. There is no legal basis yet for demanding more in the EU at present. That could change soon: the Commission has already proposed making the manipulation of benchmarks a criminal offence under the Market Abuse Directive and it is aiming to publish a proposal for a regulation on benchmarks. Of course we will also make sure that the right intensity of regulation is achieved and that the tasks are sensibly divided between national and European institutions.

There is also movement at the global level: the Financial Stability Board (FSB) will investigate possible alternatives for LIBOR and Euribor. Do you agree with this as well?

In principle. I’m glad we were able to convince the other FSB members not to shy away from progressive ideas. It was also the right decision to bring the private sector on board, since it is ultimately responsible for developing viable alternatives to problematic benchmarks, and for making interim arrangements. The FSB will support this work and in particular will examine critically the quality of the benchmarks, governance and the processes involved. You can’t take a piecemeal approach to the problem – you have to tackle it by the roots.

In parallel, BaFin is investigating whether there were any irregularities among German panel banks. Are there any grounds for concern?

We already started taking a close look at the processes at the institutions on the LIBOR and Euribor panels last year, and we’re also conducting special inspections. This process takes time. After all, the issues involved are very complex – they have evolved over many years and in some cases relate to multiple branches of a credit institution. That’s why we don’t have any final results yet. But right now it doesn’t look as though German institutions were involved in systematic criminal activity. Rather, it seems that individual traders attempted to exploit the weaknesses of rates such as LIBOR and Euribor to their own advantage. In fact, even a slight change in an underlying reference rate can result in significant profits for a large derivatives portfolio. The absence of adequate risk processes at the institutions facilitated this in some cases.