Timothy Lane is deputy governor of the Bank of Canada.
Trust is fundamental to the world of finance. Recent developments concerning financial benchmarks in some jurisdictions have shaken that trust.
These benchmarks were developed to provide an unbiased, arm’s-length measure of market conditions and have come to be widely used throughout financial markets. For instance, interbank related interest rate benchmarks are used globally to determine the interest rate paid on trillions of loans and securities.
Recent headlines, such as those concerning the London Interbank Offered Rate (Libor), suggest some benchmarks may have been influenced improperly by various individuals for personal gain. This is alarming for organizations that use financial markets. For example, asset managers might wonder if their returns were affected by manipulation of financial benchmarks. It is something that has been taken very seriously by central banks and regulators around the world.
Canadians might wonder about the integrity of domestic benchmarks, like the Canadian dealer offered rate (CDOR), which is used to price about $10-trillion in interest-rate swaps and exchange-traded derivatives. CDOR is based on a daily survey of banks, which indicate the rate at which they would be willing to lend to corporate customers through Bankers Acceptances.
CDOR’s design includes crucial differences from Libor. Notably, CDOR reflects the rate at which the banks would be willing to lend, not borrow (like Libor). Since banks are committed to lending to companies based on CDOR, and because borrowers choose when and at what maturity to borrow, there is a greater incentive for honesty.
While there is no evidence of manipulation affecting CDOR or other Canadian benchmarks, we must not be complacent. Given its vital role in our financial system, Canadian authorities, including the Bank of Canada, and the financial industry are working to strengthen the governance and oversight of CDOR.
Canada will follow a set of best practices issued last summer by a group of financial market regulators from around the world, the International Organization of Securities Commissions (IOSCO), and which were endorsed by the G-20 and the Financial Stability Board.
A review of existing practices published last year by the Investment Industry Regulatory Organization of Canada identified some weaknesses and governance issues in the CDOR process, as well as a need to strengthen oversight.
Since CDOR submissions all come from banks, the relevant authorities have agreed that the Office of the Superintendent of Financial Institutions, which oversees banks, should supervise the effectiveness of governance and risk controls surrounding banks’ CDOR submission processes. More broadly, in its February budget, the federal government announced it will legislate a regulation-making authority covering banks’ financial-benchmark submissions.
In another important step, the banks on the CDOR panel will also soon release a code of conduct outlining, among other things, minimum standards for submission methodology, internal oversight and records retention.
The international standards will also be used to strengthen governance for other significant benchmarks, including the Canadian Overnight Repo Rate Average, the reference rate for the sizable Overnight Index Swap market.
Since foreign exchange benchmarks have come under question elsewhere, the Bank of Canada will review the indicative exchange rates it posts every day on its website. These rates are essentially published for analytical purposes, but they have come to be used in some market transactions. While there is no evidence of market manipulation affecting these rates, which are based on market transactions and market quotes, we are reviewing how they are used in the financial markets and our approach to publishing them. Issues relating to how these foreign exchange benchmarks are structured and calculated, as well as used by market participants, including banks, are now being examined by global authorities.
Robust financial benchmarks are to markets what reliable units of weights and measures are to retailers. Whether it is a litre of wine, a pound of butter or an interest rate benchmark, there should be no question that measurements for commercial and financial transactions are accurate and fair. The Bank of Canada and its partners are working hard to ensure that trust is restored.