## Fixing the Fixings: What Road to a More Representative Money Market Benchmark? — _wp13131

## Source details

**Canonical URL:** [Fixing the Fixings: What Road to a More Representative Money Market Benchmark? — _wp13131](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp13131.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp13131.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp13131.pdf.json)

---

### Abstract and Executive Points
- Interest rate derivatives on major currencies, with notional outstanding amounts adding up to hundreds of trillions, are mostly indexed on Libor and Euribor benchmarks, as are hundreds of billions in loans to enterprises, mortgages and other retail loans to the real economy.
- The paper proposes a more ambitious benchmark design: a trade-weighted index that would systematically pool all short-term wholesale funding operations of banks per tenor.
- JEL Classification Numbers: G10, G15, E43.
- Keywords: Libor, Euribor, fixings, Unsecured Money Market, and Benchmarking System.
- Paper identification: WP/13/131; May 2013.

### The role and scale of Libor and Euribor
- Key statistics and market scale:
  - Libor referenced in variable rate transactions with a notional outstanding value of at least $300 trillion.
  - Euronext data (2011): three-month Euribor offered rate futures contracts traded on LIFFE total notional amount €242 trillion.
  - Euronext data (2011): Euribor offered rate options on futures total notional amount €126 trillion.
  - BIS (end-2011): notional amount outstanding of OTC interest rate derivatives (FRAs, swaps and options) was $504 trillion.
    - By currency: euro-referenced notional amounts $184 trillion (of which $143 trillion related to interest rate swaps, $17 trillion to FRAs and $23 trillion to interest rate options), exceeding US dollar-referenced amounts $161 trillion.
  - At end-March 2012, on average almost 60% of total loans to the non-financial sector in the euro area had floating rates; share of loans to households based on floating rates reached 40%.

### Background — paradigm shift in the money market ecosystem
- Structural changes since the 1990s:
  - Market participants expanded to include foreign central banks, institutional investors, corporations, loosely regulated non-bank financial institutions, pension funds, insurance companies.
  - “Money market” ceased to be synonymous with “interbank market”; liquidity distribution and funding channels fragmented.
  - Banks’ deposit bases shifted toward money market funds; banks increasingly borrowed via CD issuance or repo operations.
- Regulatory shifts:
  - Basel-related asymmetric capital charges incentivized banks to use unsecured money markets primarily for borrowing while directing lending to less capital-intensive channels (e.g., repo), hollowing out the unsecured interbank market.
- Result: offered rate benchmarks became less representative of banks’ wholesale funding costs while gaining weight as pricing anchors for short-term derivative contracts.

### Fixings, proxy-hedging, and market-structure implications
- Nature of fixings:
  - Declarative fixings: Libor, Tibor, Euribor.
  - Actually-traded references: EONIA.
- Importance:
  - Short-term interest rate fixings convey forward rate information crucial for pricing fixed-income instruments and ensuring internally consistent, non-arbitrage pricing.
- Proxy-hedging practices:
  - Market-makers hedge based on liquidity and predictable basis relationships (e.g., EONIA swaps hedged with Euribor swap rates) rather than exact underlying instruments.
  - The explosion in interbank rate-indexed derivatives trading and intensive proxy-hedging shifted the centre of gravity of money market fixing influence toward derivative desks.

### Consequences and risks
- Divergence risks:
  - Broadening of wholesale funding channels while continuing to use interbank offered rate references generated divergence risks between Libor outputs and actual banks’ wholesale funding costs, creating large asset-liability risks for banks.
  - These risks were long concealed by the generalized narrowing of credit spreads in the late 1990s and 2000s.
- Hedging failures in stress:
  - Examples: basis swaps such as Libor-OIS failed to provide adequate hedging when most needed (e.g., 2008).
- Central bank concern:
  - Interbank fixings must properly reflect market conditions because they serve as a basis to price credit to the real economy and, if distorted, would impair the transmission of monetary policy.

### Liquidity conditions and the “wedge” between published fixings and wholesale funding costs
- Post-crisis practitioner view: the wedge between published fixings and actual wholesale funding costs is the “elephant in the room”.
- Causes of wedge:
  - Absence of a genuinely active market for term unsecured lending operations forces banks to heuristically gauge rates.
  - Actual wholesale funding costs derive from repo market access, collateral quality, FX swap market access, and other variables.
- Existential threat: the wedge undermines the proper functioning of interbank offered rate references.

### Facts and figures on market structure and turnover
- Cash and derivatives segments mostly OTC, reducing quantitative transaction data availability.
- Indicators of a drying-up unsecured wholesale funding channel while derivatives activity soared:
  - Interbank unsecured operations (all maturities) represented only 15–20% at most (namely in Austria and Belgium) of banks' balance sheet in Q2 2012, with less than 10% for Germany, France and the United Kingdom (both deposits and loans).
  - Total short-term wholesale borrowing by banks reached even 40% of banks' balance sheet in France in the same period.
- Euro area money market trends (2002–2012):
  - Daily turnover in the unsecured segment declined.
  - Turnover on secured operations (repo) multiplied by a factor of 4.
  - Other funding channels (FX swaps, EONIA swap trading) experienced massive expansion.
  - Maturity breakdown: 96% of unsecured borrowing operations' daily turnover comes from transactions with a maturity less than one month (70% for the overnight segment), maturities not used for Libor-type fixings.
- OTC derivatives daily turnover:
  - Almost tripled in ten years; around 2 trillion USD equivalent in 2010, with swap operations amounting to two thirds.
- Interest rate instruments average daily turnover (April survey years, in billions of USD):
  - 1998: 265; 2001: 489; 2004: 1,025; 2007: 1,686; 2010: 2,083.
  - FRAs: 74, 129, 233, 258, 601.
  - Swaps: 155, 331, 621, 1,210, 1,275.
  - Options and other products: 36, 29, 171, 217, 208.
  - Memo: Turnover at April 2010 exchange rates: 4/ 310, 640, 1,085, 1,680, 2,083.
  - Exchange-traded derivatives: 1,381, 2,188, 4,524, 6,099, 8,142.

### Recent literature on money market fixings: evidence and interpretations
- Literature is sparse and mixed on mispricing of BOR fixings; many studies use BOR–OIS spread as a stress indicator without questioning the spread’s information content.
- Selected study findings:
  - Gyntelberg and Wooldridge (2008): potential biases from strategic behaviour but conclude fixings worked well in dislocation; trimming extremes is effective.
  - Michaud and Upper (2008): central bank operations instrumental in cooling Libor/OIS spread.
  - Brousseau et al. (2009):
    - Found “something deeply unusual happened on Euribor offered rate fixings in the post-Lehman period” in the form of a deterministic trend without obvious economic explanation, possibly reflecting “...coordination between individual fixing contributors...” and making the fixing “entirely virtual”.
    - Empirical conclusions:
      - Pre-Lehman: strong bi-directional Granger-causality between 3-month deposit interest rate and 3-month OIS swap index.
      - Post-Lehman: deposit rate no longer Granger-causes OIS; OIS continues to Granger-cause deposit rate; deposit rate displays a deterministic trend.
      - From September 2008, empirical distribution of daily returns of the Euribor fixing diverged significantly from the OIS distribution; pure randomness deemed extremely unlikely.
- Paper’s normative stance: benchmark status should be based on representativeness—capacity to reflect trading conditions and serve as a reliable pricing anchor.

### Incentives, potential conflicts and the limits of self-regulation
- Paradoxes in fixing incentives:
  - Manipulations that benefit one trading unit (e.g., short-term Interest Rate Swaps) may harm the institution’s overall balance sheet.
- Structural biases by bank type:
  - Universal banks with net long liquidity may seek higher fixings.
  - Merchant banks structurally short liquidity may seek lower fixings.
- Hedging instruments (basis swaps, swaptions) increase complexity.
- Diversity of biases could balance out; reputational risk may deter manipulation, but self-regulation has limits as revealed by recent events.

### Approaches to a more representative benchmarking system — Overview
- Reform options range from quick incremental fixes to a full overhaul:
  - A. The quickest options (incremental reforms to existing fixing processes).
  - B. Going trade-weighted on unsecured interbank operations (transaction-based benchmarks).
  - C. Jumping the Libor cliff into the OIS liquidity pool (OIS-based references).
  - D. Towards a Full Overhaul: Total Cash Pool Index (TCPI) pooling all short-term wholesale funding operations.
- Any chosen option requires full industry support to be effective.

### A. The quickest options (incremental reforms)
- Maintain declarative approach, no reference to traded volumes, trimming of extremes.
- Advantages:
  - Minimizes legal complexities from changing benchmarks (“continuity risk”).
- Wheatley report proposals:
  - Reform governance of the index, increase accountability of panel banks, refine calculation process, discontinue publication of some unused tenors and currencies.
  - Some support for incorporating transaction-based data without specifying mechanisms.
- Practitioner views: mixed on transaction-based data (Euribor European Stakeholders workshop, 12 October 2012).
- Main issue with retaining declarative approach and unsecured interbank scope:
  - Assumes revival of wholesale unsecured market funding channel for banks.
  - V. Le Lesle (IMF, 2012): odds for resumption of unsecured segment are dim given regulatory environment and pressure to increase claim seniority.

### B. Going trade-weighted on unsecured interbank operations
- Potential benefits:
  - Transaction-based, trade-weighted benchmarks could increase reliability, representativeness and integrity; real transaction data should impede manipulation.
  - Successful practical examples: Eonia and Fed Funds effective swap markets.
- Preconditions for feasibility:
  - Sufficient market liquidity (enough underlying transactions); insufficient transaction volume on key tenors undermines reference relevance.
  - Wholesale unsecured segment must be representative of general wholesale funding conditions for financial institutions.
- Practical considerations:
  - Market participants often propose complementing transaction data with “expert judgment” or model input.
  - High uncertainty about banks' funding channels in the post-crisis environment makes meeting preconditions difficult (Le Lesle, 2012).
  - A full restoration of wholesale unsecured markets could make this solution appropriate.

### C. Jumping the Libor Cliff into the OIS Liquidity Pool — OIS-based alternative
- Rationale:
  - OIS fixings (e.g., Eonia swap prices) lack prime bank credit risk and could provide a quasi-banking risk-free reference for cash and derivatives.
- Practical obstacles:
  - Capital market liquidity for interest rate derivatives is concentrated on Libor-type linked derivatives; a switch requires coordination among lawmakers, derivative end users and the financial industry across jurisdictions.
  - Discontinuation of interbank offered rates must be orchestrated with phasing-in of contractual templates and rules for conversion of existing Libor-indexed derivatives to OIS-based ones.
  - Central authority coordination needed to fix spreads or margin adjustments for all swap maturities and frequencies; NPV adjustments would be inevitable.
- Evidence of migration toward OIS practices:
  - Mid-2010 market changes: pricing, hedging, risk management, margin computations and options quotation adjusted to cope with Euribor/OIS spread volatility.
  - Cash flow discounting practices using the OIS curve began to dominate pricing and valuation.
  - Specific actions:
    - June 17, 2010: London Clearing House began using OIS curves to discount interest rate swap portfolios.
    - August 11, 2010: ICAP changed pricing methodology to use OIS yield curve for discounting.
  - Implementation challenges: greater pricing complexity, potential programming errors, and the use of two yield curves (OIS for discounting and Libor/Euribor for forwarding).
  - Extension of Eonia swap maturities: brokers progressively integrated longer maturities; ICAP reached the 50-year tenor on 15 August 2012.
  - Industry investments in staff training and IT indicate support for an OIS-based benchmark if coordinated.

### D. Towards a Full Overhaul: Total Cash Pool Index (TCPI) Benchmark
- Definition:
  - Trade-weighted index pooling all short-term wholesale funding operations of banks below one year into maturity buckets.
  - Aggregates unsecured interbank borrowing, issuance of CDs, general collateral repo operations, security lending, and cross-currency funding operations through FX swaps—any wholesale borrowing transaction with a cash leg bearing interest.
- Expected benefits:
  - Pools across segments to address scarcity in specific segments, providing a general sense of overall bank funding cost.
  - Represents banks' wholesale short-term liability base fairly; manipulation difficult due to large underlying instrument pool and reliance on traded data.
  - Reinforces transparency for indexed debtors, potentially narrowing margins and improving credit affordability.
  - Aligns with centralized Treasury management practices and encourages diversification of financing sources, reducing funding mismatch risks.
  - May reduce reliance on basis-risk derivatives and their costs (example: basis swap surge in 2008 from a couple of basis points to more than 300 bps).
- Transition and implementation:
  - Coexistence with Libor-type references during phased migration could allow smooth market-driven adoption; newly issued instruments (IRS, FRNs) could be indexed to TCPI while legacy instruments expire.
  - Convergence of reference curves could facilitate least-cost NPV adjustments for longer-dated instruments; OIS-related references can serve as interim solutions.
- Criticisms and operational risks:
  - Migration costs and contract continuity issues are significant; long-run benefits may offset these costs.
  - Risk of misreporting if reporting system is too complex; mitigants include joint efforts between practitioners and banking associations.
  - Public sector role (regulatory, accounting, institutional) could hasten migration (BIS, 2013).
- Stabilizing properties:
  - Reflects credit component of interbank borrowing and asset-base quality via secured operation costs, creating self-stabilizing incentives for matching indexed assets and liabilities.

### Key weaknesses of trade-weighted reference rates and promising alternatives
- Weakness:
  - Currently low market activity in term unsecured segments undermines the viability of a pure trade-weighted reference rate in the post-crisis environment.
- Promising alternative:
  - Replacement by swap indexes based on trade-weighted overnight reference rates is promising because overnight instruments displayed impeccable liquidity performance during crisis peaks.
- Paper’s preferred ambitious design:
  - Systematic pooling of all short-term wholesale funding operations of banks (TCPI) could overcome shallowness in specific subsectors.

### Legal, industry and transition considerations
- Legal implications:
  - Any change of benchmark has considerable legal implications given the outstanding amount of interbank offered rate-referenced derivative products; such implications are unavoidable.
- Industry endorsement:
  - Successful new benchmarking requires financial industry endorsement; intensified exchanges with practitioners are necessary for gradual migration toward a representative, relevant and lasting benchmark.
- Transition mechanisms:
  - Phased coexistence, use of OIS as interim, and central coordination to manage NPV adjustments, contractual continuity and market adoption are essential.

### Concluding remarks and core recommendation
- Central problems:
  - Allegations of manipulation and the “observed extinction” of the term unsecured market segment that underpinned money market fixings.
  - Interest rate derivatives with notional outstanding amounts “adding up to hundreds of trillions of exposure” and hundreds of billions in loans and retail debt are indexed on these benchmarks.
- Core thesis:
  - The representativeness of the new benchmarking system for banks' actual wholesale funding costs should be the key parameter to distinguish candidate benchmarks.
- Options considered:
  - Improved governance and transparency (incremental fixes).
  - Migration to OIS-based benchmarks (interim or structural).
  - Total Cash Pool Index (TCPI) pooling all traded wholesale funding (ambitious overhaul).
- Transition note:
  - Transitional paths (phased coexistence, OIS interim) and central coordination are essential to manage NPV adjustments, contractual continuity and market adoption.

*Source: _wp13131 — IMF Working Paper WP/13/131 (Sections 1–4).*

### Section 1

### Fixing the Fixings: What Road to a More Representative Money Market Benchmark? — Section 1

### Abstract and Executive Points
- Interest rate derivatives on major currencies, with notional outstanding amounts adding up to hundreds of trillions, are mostly indexed on Libor and Euribor benchmarks, as are hundreds of billions in loans to enterprises, mortgages and other retail loans to the real economy.
- The paper proposes a more ambitious benchmark design that would consist of a trade-weighted index that would systematically pool all short-term wholesale funding operations of banks per tenor.
- JEL Classification Numbers: G10, G15, E43.
- Keywords: Libor, Euribor, fixings, Unsecured Money Market, and Benchmarking System.
- Paper identification: WP/13/131; May 2013.

### The role and scale of Libor and Euribor
- Libor is the most frequently used benchmark for interest rates globally, referenced in variable rate transactions with a notional outstanding value of at least $300 trillion.
- Euronext data (2011): total notional amount of the three-month Euribor offered rate futures contracts traded on LIFFE was €242 trillion; total notional amount of the Euribor offered rate options on futures was €126 trillion.
- BIS (end-2011): notional amount outstanding of OTC interest rate derivatives (FRAs, swaps and options) was $504 trillion.
  - By currency, notional amounts referenced to euro interest rates were $184 trillion (of which $143 trillion related to interest rate swaps, $17 trillion to FRAs and $23 trillion to interest rate options), exceeding amounts referenced to US dollar rates ($161 trillion).
- At end-March 2012, on average almost 60% of total loans to the non-financial sector in the euro area had floating rates; the share of loans to households based on floating rates reached 40%.

### I. Introduction — problem statement and context
- Libor and Euribor have been key global benchmarks and behaved similarly until recently (Figures 1 and 2 referenced).
- Allegations of Libor manipulation prompted the Wheatley Review of Libor to consider:
  (i) necessary reforms to the current framework for setting and managing Libor;
  (ii) the adequacy and scope of sanctions to appropriately handle Libor manipulation; and
  (iii) whether analysis of the failings of Libor has implications for other global benchmarks.
- IOSCO, EBA and ESMA launched public consultations on money market reference issues; the ECB provided opinions in these consultations.

### II. Background — paradigm shift in the money market ecosystem
- Offered rate benchmarks were set up during the 1980s when wholesale unsecured interbank operations were the main refinancing channel beyond customer deposits.
- Since the 1990s a paradigm shift occurred:
  - Market participants expanded: foreign central banks, institutional investors, corporations, loosely regulated non-bank financial institutions, pension funds, insurance companies.
  - “Money market” ceased to be synonymous with “interbank market”; the distribution of liquidity and funding channels fragmented.
  - Banks’ deposit bases shifted toward money market funds; banks increasingly borrowed via CD issuance or repo operations.
- Regulatory changes (Basel) produced asymmetric capital charges that incentivized banks to use unsecured money markets primarily for borrowing while directing lending to less capital-intensive channels (e.g., repo), contributing to the hollowing out of the unsecured interbank market.
- Offered rate benchmarks became less representative of banks’ wholesale funding costs while gaining weight as pricing anchors for short-term derivative contracts.

### Fixings, proxy-hedging, and market structure implications
- Fixings should be clear and transparent snapshots of a given price or rate; examples include declarative fixings (Libor, Tibor, Euribor) and actually-traded references (EONIA).
- Short-term interest rate fixings convey forward rate information crucial for pricing a wide range of fixed-income instruments and ensuring internally consistent, non-arbitrage pricing.
- Proxy-hedging is widespread: market-makers choose hedges based on liquidity and predictable basis relationships rather than exact underlying instruments (e.g., EONIA swaps hedged with Euribor swap rates).
- The explosion in interbank rate-indexed derivatives trading and intensive proxy-hedging increased exposures for short-term derivative books, shifting the center of gravity of money market fixing influence toward derivative desks.

### Consequences and risks
- The broadening of wholesale funding channels while continuing to use interbank offered rate references generated divergence risks between Libor outputs and actual banks’ wholesale funding costs, creating large asset-liability risks for banks.
- These risks were long concealed by the generalized narrowing of credit spreads in the late 1990s and 2000s.
- Examples of the limited hedging performance in times of stress: basis swaps such as Libor-OIS failed to provide adequate hedging when most needed (e.g., 2008).

### Proposed approaches (overview from Section III)
- The paper reviews options ranging from quickest incremental reforms to more structural changes:
  - “The Quickest Options” (incremental fixes to existing fixing processes).
  - “Going Trade-Weighted on Unsecured Interbank Operations?” (a trade-weighted index on unsecured interbank trades per tenor).
  - “Jumping the Libor Cliff into the OIS Liquidity Pool – A View from Short-Term Derivatives Markets” (shift toward OIS-related references).
  - “Towards a Full Overhaul: A Total Cash Pool Index (TCPI) Benchmark” (a comprehensive benchmark pooling all short-term wholesale funding operations per tenor).

### Conclusion (preview)
- Industry disagreement exists on whether Libor should be reformed or replaced; replacement is justified only if Libor is severely compromised, cannot be adequately improved by reforms, and a suitable replacement is feasible.
- The paper argues for consideration of a trade-weighted pooling benchmark that systematically aggregates short-term wholesale funding operations of banks by tenor as a more representative alternative.

*Prepared by V. Brousseau, A. Chailloux, A. Durré; Authorized for distribution by Craig Beaumont; May 2013 — IMF Working Paper WP/13/131.*

### Section 2

### _wp13131 - Section 2

### Liquidity conditions and the “wedge” between published fixings and wholesale funding costs
- Ample liquidity conditions cushioned the interest rate and credit cycle and the subsequent limited movements of spreads reduced the risks of a substantial wedge between banks actual wholesale funding costs and the published interbank offered rate references.
- Post-crisis, money market practitioners view this wedge as the “elephant in the room”.
- In the absence of a genuinely active market for term unsecured lending operations:
  - banks must heuristically gauge the rate at which such operations would take place;
  - actual wholesale funding costs result from a complex combination of repo market access, the quality of collateral, access to the foreign exchange swap market, and other variables.
- The existence of this wedge is an existential threat to proper functioning of interbank offered rate references.
- Central banks require that interbank fixings properly reflect market conditions because these fixings:
  - serve as a basis to price credit to the real economy; and
  - if distorted, would impair the transmission of monetary policy.

### Facts and figures on market structure and turnover
- Cash and derivatives segments of the money market are mostly over-the-counter (OTC), reducing quantitative information on transaction prices and volumes.
- Indicators point to a gradual drying-up of unsecured wholesale funding channels for banks, precisely as:
  - the benchmarking role of Libor and Euribor through derivatives activity soared; and
  - wholesale funding in general (including repo operations and short-term security issuance) increased dramatically.
- Bank balance sheets and surveys confirm the observation:
  - Interbank unsecured operations (all maturities included) represented only 15–20% at most (namely in Austria and Belgium) of banks' balance sheet in the second quarter of 2012, with less than 10% for Germany, France and the United Kingdom (both deposits and loans).
  - Total short-term wholesale borrowing by banks was significantly higher in Asia, Europe and North America over the same period, reaching even 40% of banks' balance sheet in France.
- Euro area money market (detailed public data):
  - Daily turnover in the unsecured segment declined between 2002 and 2012.
  - Turnover on secured operations (repo), initially well below unsecured operations, was multiplied by a factor of 4 between 2002 and 2012.
  - Other funding channels and short-term market segments (FX swaps, EONIA swap trading) experienced a massive expansion over the last 10 years, unlike unsecured term borrowing operations.
  - Maturity breakdown: 96% of unsecured borrowing operations' daily turnover comes from transactions with a maturity less than one month (in particular 70% for the sole overnight segment), maturities that are not used for the calculations of Libor-type fixings.
- Wider market activity:
  - OTC derivatives daily turnover as calculated for the BIS Triennial Survey almost tripled in ten years.
  - OTC derivatives daily turnover was around 2 trillion USD equivalent in 2010, with swap operations amounting to two thirds according to the last available BIS data referenced.
- Euro area MFIs liabilities:
  - Breakdown of liabilities (outstanding amounts at the end of the period in EUR billions, excluding the Eurosystem) shows the increasing importance of wholesale funding for banks.
- Table and chart highlights (as reported):
  - Interest rate instruments daily turnover (average daily turnover in April, in billions of USD): 1998: 265; 2001: 489; 2004: 1,025; 2007: 1,686; 2010: 2,083.
  - FRAs: 74, 129, 233, 258, 601 (across the survey years listed).
  - Swaps: 155, 331, 621, 1,210, 1,275 (across the survey years listed).
  - Options and other products: 36, 29, 171, 217, 208 (across the survey years listed).
  - Memo: Turnover at April 2010 exchange rates: 4/ 310, 640, 1,085, 1,680, 2,083 (across survey years).
  - Exchange-traded derivatives: 1,381, 2,188, 4,524, 6,099, 8,142 (across survey years).
- Notes and sources referenced in the section:
  - Sources include SNL Financial, ECB (2012), SDW, Bank for International Settlements.
  - Specific ECB data reference: outstanding amounts page (not reproduced here).

### Recent literature on money market fixings: evidence and interpretations
- Literature on information content of interbank offered rate (BOR) fixings is sparse; results on possible mispricing are mixed.
- Many studies focus on BOR–OIS spread as a stress indicator without questioning the genuine information content of the spread.
- Few studies examine a possible gap between fixing levels and actual wholesale unsecured funding costs.
- Findings from selected studies summarized:
  - Gyntelberg and Wooldridge (2008):
    - Highlight potential biases related to participants' strategic behaviour.
    - Conclude fixings worked well in market dislocation and dispersion is a consequence of market turmoil rather than flawed fixing process.
    - Argue safeguards (trimming extremes) work well.
  - Michaud and Upper (2008):
    - After studying Libor drivers during turmoil, suggest central bank operations are instrumental in cooling the Libor/OIS spread.
  - Brousseau et al. (2009) (earlier IMF research):
    - Focused on pricing dynamics of fixings pre- and post-Lehman.
    - Concluded that “something deeply unusual happened on Euribor offered rate fixings in the post-Lehman period” in the form of a deterministic trend without obvious economic explanation, possibly reflecting “...coordination between individual fixing contributors...” and making the fixing “entirely virtual”.
    - This paper is described as the only study in this set providing statistical and econometric evidence of the new “virtual” character of the fixing and evidence of possible manipulation.
    - Key empirical conclusions:
      - Before the crisis and up to the Lehman collapse, a strong bi-directional relationship existed between the 3-month deposit interest rate and the 3-month swap index: the 3-month deposit interest rate does Granger-cause the 3-month EONIA swap (OIS) and vice-versa.
      - Post-Lehman, a substantial break: the deposit interest rate no longer Granger-causes the OIS rate, while the OIS continues to Granger-cause the deposit interest rate; the deposit rate displays an observable linear pattern (presence of a deterministic trend).
      - From September 2008, the empirical distribution of daily returns of the Euribor fixing diverges significantly from the empirical distribution of the OIS, whereas they matched closely beforehand; pure randomness is ruled out with extremely low probability as an explanation.
- The paper's view: a benchmark's status should be based on representativeness — capacity to reflect trading conditions and serve as a reliable pricing anchor for peripheral markets.
- Elements of an ideal money market benchmark are under active debate and will be summarized later in the report.

### Incentives, potential conflicts and the limits of self-regulation
- Anecdotal evidence of abuses raises questions about paradoxes in fixing incentives.
- Manipulations that benefit one trading unit (e.g., short-term Interest Rate Swaps) may negatively impact the institution's overall balance sheet.
- Structural biases by bank type:
  - Universal banks with net long liquidity from deposit-gathering may seek higher fixings.
  - Merchant banks with a presence in capital markets and investment banking, likely structurally short liquidity, may seek lower fixings.
- Hedging instruments (basis swaps, swaptions) complicate the stakes further.
- The diversity of biases within a panel could, in theory, create a balancing process and reputational risk could deter manipulation; however, recent developments suggest self-regulation may not always prevail.

### Approaches to a more representative benchmarking system in the money market
- Investigations into Libor, Euribor and Tibor manipulation are prompting reconsideration of current benchmark definitions and proposals for improved representativeness.
- Reform options summarized range from quick fixes to full overhauls; any chosen option should receive full support of the financial industry to be effective.

A. The quickest options
- Reform interbank offered rate fixings without amending essential features: maintain declarative approach, no reference to traded volumes, trimming of extremes.
- Advantage: minimizes legal complexities from changing benchmark in contracts (“continuity risk”).
- Wheatley report approach:
  - Reforms limited in scope to be implemented quickly.
  - Proposals: reform governance of the index, increase accountability of panel banks, refine calculation process, discontinue publication of some unused tenors and currencies.
  - Expresses some support for incorporating transaction-based data without specifying how.
- Practitioner views on transaction-based data are mixed (e.g., most participants at the Euribor European Stakeholders workshop of 12 October 2012 agreed a transactions-based calculation might not be adapted to Euribor).
- Incremental changes likely favored by banking community due to sizeable litigation risks from redenomination of contracts amounting to trillions of euros and dollars.
- Main issue with keeping declarative approach and unsecured interbank scope:
  - It assumes revival of wholesale unsecured market funding channel for banks.
  - V. Le Lesle (IMF, 2012) notes the odds for resumption of unsecured segment (short or long end) are dim given regulatory environment and pressure to increase claim seniority.

B. Going trade-weighted on unsecured interbank operations?
- Shift toward transaction-based benchmarks (trade-weighted) could increase reliability, representativeness and integrity, since real transaction data should impede manipulation.
- Successful practical examples: Eonia and Fed Funds effective swap markets.
- Practical feasibility requires careful study; an efficient transaction-based benchmark demands two pre-requisites:
  - Sufficient market liquidity (enough underlying transactions); insufficient transaction volume on key tenors would undermine reference relevance.
  - Wholesale unsecured segment must be representative of general wholesale funding conditions for financial institutions to avoid discontinuity and preserve benchmark value.
- Market participants who are not opposed to trade-weighted references often envisage complementing transaction data with “expert judgment” (or model input) in producing the reference.
- High uncertainty about banks' funding channels in the post-crisis environment makes meeting these conditions difficult (Le Lesle, 2012).
- A full restoration of wholesale unsecured markets trading in the post-crisis environment could make a transaction-based solution appropriate.

*Italic: Source — _wp13131 - Section 2*

### Section 3

### _wp13131 - Section 3

### C. Jumping the Libor Cliff into the OIS Liquidity Pool – A View from Short-Term Derivatives Markets
- Key diagnostic observations:
  - Extremely high dispersion of quotes during the turmoil; funding conditions should in principle be somewhat homogeneous among contributing prime banks.
  - Near-absence of underlying market activity created a complex environment for contributing banks to quote accurate prices, fostering heuristic practices and opening scope for abuses given "trillions of dollars of notional exposure on short-term derivatives."
  - Reforms focused on governance, transparency and accountability address operational weaknesses but do not resolve the "fundamental weaknesses" or the "increasing economic irrelevance" of declarative offered-rate benchmarks as references for wholesale unsecured funding.
  - BIS (2013) proposes more radical changes, including stronger roles for central banks and public authorities in case of market failure, but does not resolve the decline of wholesale unsecured funding operations.
- OIS-based alternative:
  - Proposal: substitute interbank offered rate fixings with fixings based on OIS (Overnight Indexed Swaps) trading.
  - Rationale: OIS fixings lack prime bank credit risk (e.g., Eonia swap prices), therefore could provide a quasi-banking risk-free reference for cash and derivatives transactions; BIS (2013) Working Group highlighted many merits.
  - Practical obstacles:
    - Capital market liquidity for interest rate derivatives is currently concentrated on Libor-type linked derivatives; a switch would require organization and cooperation among lawmakers, derivative end users and the financial industry across jurisdictions.
    - Discontinuation of interbank offered rates must be orchestrated with phasing-in of industry-wide contractual templates and rules for conversion of existing Libor-indexed derivatives to OIS-based ones.
    - A central authority should coordinate timing and fix spreads or margin adjustments for all swap maturities and swap frequencies; NPV adjustments to be paid by counterparties could not be avoided.
- Evidence of market migration toward OIS practices:
  - Mid-2010 market consensus changed pricing, hedging, risk management, margin call computations and options quotation for short-term derivatives to cope with Euribor/OIS spread volatility.
  - New cash flow discounting practices using the OIS curve began to dominate pricing and valuation methodologies, affecting collateral pricing for OTC derivative clearing houses.
  - Specific market actions:
    - On June 17, 2010, the London Clearing House communicated it would start to use OIS curves to discount interest rate swap portfolios.
    - On August 11, 2010, broker ICAP modified its pricing methodology, including a change from the Euribor swap yield curve to the OIS yield curve for discounting.
  - Implementation challenges acknowledged: (i) greater complexity of pricing algorithms, (ii) potential programming errors across front/middle/back offices, (iii) use of two different yield curves—OIS for discounting and Libor/Euribor swap curve as the "forwarding curve."
  - Extension of Eonia swap maturities:
    - 2007: Eonia swaps longer than 10-year were absent.
    - Progressive integration of longer maturities by brokers; ICAP reached the 50-year tenor on 15 August 2012, following peers such as Tullett.
  - Market participants have invested in staff training, IT adjustments, and communication, indicating industry support for an OIS-based benchmark if coordinated.

### D. Towards a Full Overhaul: A Total Cash Pool Index (TCPI) Benchmark
- Definition and mechanics:
  - A trade-weighted index pooling all short-term wholesale funding operations of banks below one year into maturity buckets.
  - For a given tenor, it would aggregate unsecured interbank borrowing, issuance of CDs, general collateral repo operations, security lending, and cross-currency funding operations through foreign exchange swaps—any wholesale borrowing transaction with a cash leg bearing interest.
- Expected benefits:
  - Addresses scarcity of trading in specific segments by pooling across segments, providing a general sense of overall bank funding cost.
  - Represents banks' wholesale short-term liability base fairly; manipulation would be highly difficult due to very large underlying instrument pool and reliance on actually traded data.
  - Reinforces transparency for indexed debtors and could lead to narrower margins and improved affordability of credit indexed to the reference.
  - Aligns with centralized Treasury management practices and encourages banks to diversify financing sources, reducing funding mismatch risks.
  - May reduce dependence on basis-risk derivatives and the associated costs illustrated by the 2008 basis swap surge from a couple of basis points to more than 300 bps.
- Transition and implementation considerations:
  - Coexistence with current Libor-type references during a phased migration could allow smooth market-driven adoption; newly issued instruments (e.g., IRS, FRNs) could be indexed to the TCPI while legacy instruments expire.
  - Convergence of reference curves could facilitate least-cost NPV adjustments for longer-dated instruments; larger recourse to OIS-related references could serve as an interim solution.
  - Criticisms and operational risks:
    - Seen as a stark departure with potentially significant migration costs and contract continuity issues; these costs should be assessed and may be offset long-run by framework robustness and narrower funding spreads.
    - Risk of misreporting if reporting system is too complex; mitigants include joint efforts between practitioners and banking associations to improve transparency.
  - Public sector role: regulatory, accounting, and institutional changes could be hastened by public authorities to ease migration (BIS, 2013).
- Stabilizing and fairness properties:
  - Reflects both credit component of interbank borrowing costs and asset-base quality via secured operation costs, creating self-stabilizing features and incentives for matching indexed assets and liabilities.
  - Could reduce mismatch risks inherent in dominance of Libor-type benchmarks for asset indexation.

### IV. Concluding Remarks
- Central problems and context:
  - Reports of alleged manipulations of Libor, Tibor and Euribor benchmarks exposed ethical issues and revealed the "observed extinction" of the market segment that served as the basis for money market fixings.
  - Interest rate derivatives with notional outstanding amounts "adding up to hundreds of trillions of exposure" are mostly indexed on these benchmarks; hundreds of billions of loans and retail debts also rely on them.
  - The prevailing role of these benchmarks is largely a historical legacy rather than reflective of current banks' funding structures; the declarative-survey methodology is vulnerable when the underlying term unsecured market activity has diminished.
- Core thesis and recommendation:
  - The paper discusses technical features and implications of options for a new benchmarking system and contends that "the representativeness of the new benchmarking system for banks actual wholesale funding costs should be the key parameter to distinguish the different candidates."
  - Options considered include improved governance and transparency, a migration to OIS-based benchmarks, and a Total Cash Pool Index (TCPI) pooling all traded wholesale funding.
  - Transitional paths (phased coexistence, use of OIS as interim) and central coordination are essential to manage NPV adjustments, contractual continuity and market adoption.

*Source: _wp13131 - Section 3*

### Section 4

### _wp13131 - Section 4

### Key weaknesses of trade-weighted reference rates
- The currently low market activity in the term unsecured segments of the money market appears to be an important weakness of a trade-weighted reference rate, especially within the post-crisis environment.

### Promising alternatives
- Replacement of interbank offered rates by swap indexes based on trade-weighted overnight reference rates appears to be a more promising avenue since this instrument displayed an impeccable liquidity performance even at the climax of the crisis tensions.
- Beyond these basic and immediate options the paper argues in favor of a more ambitious benchmark design that would consist of a systematic calculated pooling of all short-term wholesale funding operations of banks, which could overcome the issue of the potential shallowness of each specific sub-component of the wholesale funding market.

### Legal and industry considerations
- Any change of benchmark shall have considerable legal implications given of the outstanding amount of interbank offered rate-referenced derivative products. They are unavoidable.
- Any successful new benchmarking system will require the endorsement of the financial industry. It is therefore necessary to intensify the exchange of views with practitioners to move gradually towards a representative, relevant and lasting new benchmark reference rate in the money market.

*Source: _wp13131 - Section 4*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2013/_wp13131.pdf_