Regulators Warn Not To Continue With LIBOR, Richard Sandor Sees a Future With Multiple Interest Rate Benchmarks

July 25, 2019 12:30 AM
American Futures Exchange launching futures on AMERIBOR
Sandor sees a world in which a variety of interest rate benchmarks operate
AMERIBOR futures focus on hedging for small and regional banks
Richard Sandor launches AMERIBOR futures on American Financial Exchange (AFX)

Richard Sandor launches AMERIBOR futures on American Financial Exchange (AFX)

What's Happening With LIBOR Interest Rates?

UK Financial Conduct Authority (FCA) CEO Andrew Bailey joined a growing choir of regulators to loudly state that LIBOR would end on its mandated expiration date at the end of 2021.

On July 16 the top UK bank regulator urged market participants “not to have misplaced confidence that LIBOR, as it exists today, will survive,” noting that there could be “conduct risk” in continuing to use the scandal-plagued benchmark if it is not accurately representative of the interest rate market.

The "Father of Financial Futures" Richard Sandor 

While authorities continue to pronounce LIBOR dead, Richard Sandor, the founder, chairman, and CEO of the American Financial Exchange (AFX) sees a more diverse outcome for the benchmark used to set trillions in global interest rates on everything from mortgages to credit card.

The “father of financial futures” sees a world in which a variety of benchmarks operate. AFX exchange created a LIBOR alternative, AMERIBOR, which he says better represents US interest rates for regional and community banks. The exchange recently received CFTC approval to trade listed derivatives contracts based on this benchmark.

"I wanted to create an American interest rate benchmark, one that sets rates based on the actual borrowing and lending done by small and mid-sized banks in the US."

Challenging consensus opinion is nothing new for the one-time University of California at Berkeley academic who became chief economist for the Chicago Board of Trade in 1972. At the CBOT, he created US 30-year Treasury futures at a time when he was told: “you can’t commoditize interest rates.” He would later go on to tackle climate change, creating a carbon futures contract that made pollution a tradeable asset – one that significantly reduced carbon emissions by taking a market-based approach to the problem.

Sandor has a different outlook on the world, which impacts how he builds a futures contract.

He starts by looking for “unambiguous evidence of ownership” that can be traded and likes products where structural change is impacting the world around it. Then create a transparent, regulated exchange-traded contract that is highly liquid, and the result is a functioning derivatives contract.  

Sandor noticed a societal structural change in 2011 while reading the Financial Times. Four traders were involved in a plot to manipulate the interest rate contract, which resulted in the Royal Bank of Scotland paying a $610 million fine. LIBOR, the London Inter-Bank Offered Rate, set interest rates by each bank member submitting an estimate of what it would charge, which was subject to trading manipulation.

But Sandor saw something bigger.

“If four people are manipulating LIBOR, it could be 40 or maybe 400.” At this point, Sandor calculated LIBOR would lose its preeminence as it would only be a matter of time before other scandals broke. Eventually, his analysis that more traders were involved in the manipulation came to pass. Large global trading firms that set the LIBOR rate would pay over $9 billion in fines amid criminal charges against a wide range of traders

AMERIBOR Interest Rate Benchmarks for Small and Regional Banks

Just the structural change Sandor needed.

Sandor was also puzzled that the United States, the largest economy in the world, didn’t have an unsecured funding benchmark. There are multiple benchmarks for everything, from stocks and commodities to bonds. Why did LIBOR so singularly dominate?

Regulators mandated the benchmark be disbanded and in 2014, the Federal Reserve and the Federal Reserve Bank of New York formed the Alternative Reference Rates Committee (AARC) to create an alternative. They launched the secured overnight financing rate (SOFR) in a bid to replace LIBOR.

After studying the issue, Sandor launched AMERIBOR in 2012 and launched American Financial Exchange (AFX) in 2015. “I wanted to create an American interest rate benchmark, one that sets rates based on the actual borrowing and lending done by small and mid-sized banks in the US.”

“Regional, community and midsized banks are the motor of this economy for job creation,” he said. Sandor points to Secured Overnight Financing Rate (SOFR’s) volatility but ultimately thinks AMERIBOR and SOFR will both be utilized by those looking to hedge interest rate risk.

AFX Growing Acceptance As Alternative Interest Rate

He and his team traveled across the US largely to mid-market towns to encourage the regional bankers to use the exchange. The smaller bankers didn’t largely connect with each other to trade interest rates. Among the first to use the platform was a small bank in Birmingham, Alabama, which started a larger trend. The exchange grew to also service broker-dealers, insurance companies, private equity firms, hedge funds, Futures Commission Merchants (FCMs), asset managers, and finance companies. It just on-boarded John Deere, for instance. In the second quarter of 2019 AFX achieved average daily volumes of near 1.9 billion.

AMERIBOR alternative interest rate to LIBOR

What About SOFR Interest Rate Benchmark?

When asked about the SOFR contract, Sandor said, “It’s great for the big banks, and AMERIBOR works for the regional banks…they’re complementary.”

AMERIBOR Futures Launching at CBOE Futures Exchange (CFE)

But the most significant revenue for the exchange is yet to come. Sandor is largely betting the success of the product will result from derivatives traded off the cash market. Futures trading on three-month and seven-day AMERIBOR contracts will begin August 16 in partnership with CBOE Futures Exchange (CFE).


About the Author

Mark Melin is a leading expert on non-correlated investing. He has taught managed futures at Northwestern University executive education program and has written, edited or contributed to four books, including High Performance Managed Futures (Wiley 2010) and The Chicago Board of Trade’s Handbook of Futures and Options (McGraw-Hill 2008) Mark is a journalist covering hedge funds for Follow him on Twitter @MarkMelin