The micro-cracks are turning into fissures, soon to be gaping crevasses as the obsolescence of our industrial age banking system plays itself out in spectacular front page headlines.
If you look at the LIBOR scandal in the context of the technology of the fast emerging information economy, it is startling that such an anachronistic process even exists in the world of 2012. In a world where every financial flow is digitized and only really exists as an entry in a database. In a world where truly enormous real-time data sets are routinely captured and analyzed in the time it takes to read this sentence. In this world, we continue to produce one of the most important inputs into global financial markets using the equivalent of a notebook and a biro.
For each (of 10) currencies, a panel of 7-18 contributing banks is asked to submit their opinion each morning on what each rate should be. The published rated is then the “trimmed arithmetic mean”; No account is taken of the size, creditworthiness or funding position of each bank, and the sample size after the ‘trimming’ for each calculation is between 4-10 banks. However, the BBA assures us that this calculation method means that “…it is out of the control of any individual panel contributor to influence the calculation and affect the bbalibor quote.” This is a sub-optimal way to calculate any sort of index, let alone one that has an impact on the pricing and outcomes of trillions of dollars worth of contracts.
In the 1980s when LIBOR was invented, this methodology might have been acceptable given the market and technological context. However we must re-evaluate how the LIBOR should be calculated in the 21st century. A few suggestions:
Include all banks in the market – not just those in London;
Collect and maintain (in quasi-real time) important meta-data for each contributing bank (balance sheet size and currency breakdown of same by both deposits and loans, credit rating, historical interbank lending positions, volatility/consistency of submissions, derivative exposure to LIBOR rates, etc.);
Collect rates and volumes for all realized interbank trades and live (executable) bids and offers (9-11am GMT each day);
Build robust, complex (yet transparent and auditable) algorithms for computing a sensible LIBOR fixing arising from this data; consider open-sourcing this using the Linux model.
This is not only possible, but relatively trivial today. Other smaller companies are already regularly digesting, analyzing and publishing analogous datasets that are as big and as complex as the new LIBOR I’m suggesting.
The management of this process could easily be outsourced to one, or many, big data companies, with a central regulatory authority playing the role of guardian of standards-the weight of which could be outsourced to other smart data processing auditors. This could continue to be the BBA (the “voice of banking and financial services”); however the political and practical reality is that it should almost certainly be replaced in this role, perhaps by the Bank of England. Given the global importance of this benchmark, it is also worth thinking creatively about what institution could best play this role. The BIS or ISO perhaps? Or a new agency along the lines of ICANN or the ITU . The role of this entity would be to set the standards for data collection, storage and computation and vet and safe keep the calculation models and the minimum standards (including power to subsequently audit at any time) required to be a calculation agent (kite mark.) Under this model, you could have multiple organizations – both private and public – publishing the calculation, and in principle if done correctly they should all get the same answer (same data in + same model = same benchmark rate.)
The solution to this – and other similar issues in global finance – either exist or are emerging at a tremendous pace. Could we be witnessing a Financial Reformation? Excellent, robust, technology-enabled solutions are entirely within our means, the question is whether the existing players have the willingness to bring these new ideas to the table.
Sean Park – Anthemis – BIO
[caption id="attachment_20279" align="alignright" width="146" caption="Sean Park"][/caption]
Sean has been involved as founding investor in a number of disruptive and highly successful new ventures such as Betfair, Weatherbill, and Seedcamp, and has extensive experience investing in and advising start-up and high growth companies in addition to over 16 years of experience working at a senior level in capital markets and investment banking.
Before founding Anthemis (and its predecessor Nauiokas Park LLP), he spent 16 years working in a variety of senior capital market roles, most recently Dresdner Kleinwort. He was also a non-executive Director of Markit Group and Board Chairman of the International Index Company (formerly iBoxx). He is currently a non-executive Director of FX Capital Group, Blueleaf Inc. and Babuki Ltd. He also sits on the advisory board of Zoopla.co.uk. He is also a Managing Director of FT Advisors, the specialist financial technology advisory business of the Anthemis Group.
He is the author of the widely read ‘Park Paradigm’, a blog focused on the future of finance and markets. Sean has a BSC in Materials Science from Rice University in Houston, Texas. He is now based in Geneva.
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