According to "The Lowdown on LIBOR" (May 29, 2008) Businessweek reporters Ben Levisohn and Lauren Young write that $150 trillion is the "value of financial products with interest rates tied to" the London Interbank Offer Rate. In pensionland, this important benchmark rate shows up in a variety of ways.
A plan sponsor that employs swaps to manage interest rate risk often plays the role of Floating Rate Payor. As LIBOR rises, so too does its cash flow obligation as part of the periodic derivative trade settlement. Hedge funds may report a return that shows a shrinking basis point spread as LIBOR takes an upturn, challenging pension funds to explain "sub-par" performance to relevant constituencies. Equity values may be depressed if issuers in which a pension fund invests depend on short-term loans tied to LIBOR. Higher rates may force delinquincies for adjustable rate mortgage borrowers, impacting the price, liquidity and riskiness of some mortgage-backed securities, These are just a few of the LIBOR-related pain points for pension investors.
The saga doesn't end with volatility and escalating levels but rather continues with the process of rate-setting itself. Fearing reprisal from capital markets as credit conditions worsen, banks are thought to be quoting rates that are lower than where they are actually able to borrow from peers. In response, the British Bankers' Association undertook a thorough review of the group of banks that determine daily LIBOR levels, used in turn to price loans, settle derivative trades and/or value securities for an assortment of currencies. The following banks are used to determine U.S. dollar LIBOR:
- Bank of America
- Barclays Bank plc
- Citibank NA
- Credit Suisse
- Deutsche Bank AG
- JP Morgan Chase
- Lloyds TSB Bank plc
- Royal Bank of Canada
- The Bank of Tokyo-Mitsubishi Ltd
- The Norinchukin Bank
- The Royal Bank of Scotland Group
- USB AG
- West LB AG.
According to a May 30, 2008 news release, a British Bankers' Association sponsored "FX and Money Markets Advisory Panel" has responsibilities to strengthen the oversight of BBA LIBOR. More details are expected shortly. Click to read "BBA Libor Panels."