LIBOR and Foreign Exchange rate manipulation

In some ways this was an accident waiting to happen.

It seems to me there was an inherent flaw in the way LIBOR and FX rates were fixed.

LIBOR was set by the British Bankers Association (BBA) asking a group of banks the rate at which they would lend to each other.  – London Inter- Bank Offered Rate - for the particular currency that the quote was asked for. 

LIBOR, the London Inter-Bank Offered Rate, is, I understand, calculated by taking the average of the rates that each member a panel of banks says it could borrow funds at, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time. The top four and the bottom four are discarded and then the average of the others is set as LIBOR. The process was handled by British Bankers Association (BBA).

It is important to note that no Bank actually has to deal at the rate they submitted. 

The members of the panel of banks are drawn from the world’s leading banks.

The interest rates are fixed for the world’s leading currencies for periods from one month to one year.

The FX rate fixing has similarities to the above process.  WM Reuters publishes rates from buy-and-sell quotations from a group of “reference banks”.  Whilst the banks probably will buy and sell at the quoted rates, front running or manipulating transactions can take place. FX rates are ‘fixed’ by taking the rates published in the Reuters display.

No institution has to have dealt at the quoted FX rate.

By contrast for exchange traded securities (stocks and bonds) and derivatives (futures and options) the daily closing prices are fixed on the basis of actual trades.

If there is an attempt to manipulate securities or derivatives prices, the price feed will track and display the change in price. Market monitoring staff and / or regulatory transaction monitoring staff will identify suspicious price movements / manipulating transactions and the trade reporting systems will enable identification of the traders who can be investigated. Front running and other manipulating transactions and devices can be traced back to individual traders as all trades are recorded.

Neither LIBOR nor FX rates are fixed on the basis of actual transactions.

In Shakespeare’s play ‘Julius Caesar’ Cassius said to Brutus “The fault, dear Brutus, is not in our stars, but in ourselves.” In similar vein in could be said of LIBOR and FX Rate fixings that the fault lies more with the nature of the benchmark rather than the people manipulating it. 

                      

Perhaps the systems for setting LIBOR and FX rates need to change?

Perhaps the benchmark could be the rate at which the central bank, the Bank of England will provide liquidity / deal in foreign exchange?