Who’s looking after Libor’s mysterious Canadian cousin?
By John Greenwood, October 10, 2012
Just who’s in charge of Cdor?
It’s an important question, because financial products priced in relation to the Canadian equivalent of Libor are so widely held — by corporations, governments, banks and pension funds — they affect virtually all Canadians.
Why are the major players unable to say who is responsible for making sure proper procedure is followed and that the end result is accurate?
The Investment Industry Regulatory Organization of Canada announced on July 13 that while it wasn’t “aware of concerns” with the Canadian Dealer Offered Rate (Cdor), the ongoing issues around Libor “point to a need for increased scrutiny of such survey-based reference rates.”
Canada’s investment industry regulator has not made a peep since it announced this past summer it was launching a “review” of Cdor.
Interestingly, the regulator states that it oversees only the investment dealers that participate in setting Cdor: in other words, it’s not responsible for the rate itself.
Meanwhile, a request for comment on who’s in charge of Cdor from the Bank of Canada was redirected back to IIROC — which according to Jeremy Harrison, an assistant director in the Bank of Canada’s public affairs department, is the main regulator for Cdor. Lucy Becker, a spokeswoman for IIROC, declined a request by the Financial Post to discuss the matter.
Bank of Nova Scotia, Canadian Imperial Bank of Commerce and HSBC are all on the Cdor panel but none of the three were able to comment on the matter.
According to Jack Rando, director of capital markets at the Investment Industry Association of Canada, the Investment Dealers Association, its predecessor organization, was responsible for both conducting the Cdor survey and providing regulatory oversight but gave up those duties several years ago as part of a restructuring.
“From an IIAC perspective, we don’t have any involvement with Cdor,” said Mr. Rando.
But if it’s this important, why are the major players unable to say who is responsible for making sure proper procedure is followed and that the end result is accurate?
The Libor scandal is a major deal. Barclays Plc has already paid about US$450-million to settle allegations that it tried to manipulate the rate and more than a dozen other banks around the world have come under investigation.
Libor — essentially the rate at which banks lend to each other — is a global benchmark affecting prices of more than US$500-trillion of financial assets.
Like its London-based cousin, Cdor aims to gauge banks’ appetite for lending to one another. Each morning a panel of nine leading banks is asked what they would bid for bankers acceptances maturing in one month, three months, six months and various other durations. The lowest and highest prices are eliminated and the remainder averaged to generate the official rate.
As a primarily domestic rate, it has a smaller footprint than Libor but it still affects everything from floating rate notes and plain vanilla loans to interest rate swaps. Or take the bankers acceptance futures contract, or BAX, on the Montreal Exchange, the most heavily traded product on the exchange. In 2011, BAX contracts with a notional value of more than $20-trillion changed hands.
A top U.S. regulator recently presented a simple test to determine whether Libor is compromised.
In a recent speech to the European parliament, Gary Gensler, chair of the Commodity Futures Trading Commission, observed that real markets tend to fluctuate up and down, especially in times of uncertainty. “Just like stocks and bonds, short-term interest rates experience volatility – movement in levels within a day and across days,” Mr. Gensler said in his July 24 address. “This is the natural course of a market that responds to and incorporates new information.”
Yet Libor has stayed flat for extended periods despite the turmoil of recent years, he said.
To illustrate, Mr. Gensler presented data showing that out at least one major European bank involved in the setting of Libor changed its submission just 10 times during a six-month period this year.
“When market participants submit for a benchmark rate that lacks observable underlying transactions, even if operating in good faith, they may stray from what real transactions would reflect. Like walking in a dark forest, it’s easy to get lost, particularly over time. In addition, when a benchmark is separated from real transactions, it is more vulnerable to misconduct.”
Interestingly, the Canadian version also flatlines for extended periods. For most of August, September and the first three days of October, one-month Cdor hovered between 1.215% and 1.218%, according to Bloomberg. Indeed, for 14 straight days it sat at 1.21643%.
So, how representative of the actual market are the bids that make up Cdor?
In 2008 in the depths of the financial crisis, credit markets froze up around the world, including in Canada. Even bankers acceptances were hit. Even when the storm was at its worst, Cdor rates continued to be announced daily.
“When you’re allowed to put a number down but you don’t actually have to trade on it, I don’t know how much you can trust the number,” said Brian Eby, a portfolio manager at Connor, Clark & Lunn Investment Management Ltd. in Vancouver. Mr. Eby said he’s not aware of any problems with Cdor “but it’s certainly open for manipulation.”
Gurpreet Banwait, product director at FinancialCAD Corp., said part of the problem may be occasional lack of trading in the bankers acceptance market.
“We don’t see any of the larger institutions dealing with [bankers acceptances] which might explain why you don’t see much movement in the rate itself,” said Mr. Banwait.