America Rolls Out Its Libor Replacement

by the Federal Reserve Bank of New York today. It's basically the u s is LIBOR replacement, and so fur's debut is a critical step in the effort to wean more than three d fifty trillion dollars of securities off Libor. Joining me is Eric Tally, co director of the Millstein Center for Global Markets and Corporate Ownership at Columbia Law School. Eric, we've talked a lot on the show about the rigging of Liebor by US and European lenders that were forced

to pay billions of dollars to settle charges. Is that the main reason for the push to replace library or

are there other reasons? I think in part it is that, but you have to remember that the reason for the rigging scandal was itself born of the very design of libor, which was to try to collect an enormous amount of information about all kinds of different tenors of borrowing in different types of securities, so much so that the banks that we're having to make the reports couldn't actually report that they were doing transactions for some of the reports

that they were supposed to be talking about. So it quickly became known that this was sort of a hypothetical form of reporting. It was almost an invitation for various types of manipulation. So I think in part this is because of the scandal, the library reporting scandal, but that itself the seeds for that, I think we're sown and what was ultimately a well intentioned but poorly designed products. So what is sulfur and how is it better than library? Well,

here's what sulfur does. So the sofa rate basically uses uh not just hypothetical statements about what cost of borrowing would be, but uses a specific type of borrowing, which is overnight repo or repurchase agreements. This is a very very active market and instead of basing it on a survey, you can actually benchmark the sofa rate to the you know,

the actual transactions that are made in the market. That turns out to be very very helpful because it's not hypothetical, it's real, and its adjusts in a real way from a day to day basis. So so in in in going with this new benchmark rate, the New York Fed has has essentially decided that, uh, that that or that the Alternative Reference Rate Committee has decided that this was uh, you know, an area where data or quality of data was going to eclipse the you know, the heterogeneity of

the product. That's also one of the weak spots of the of the new rate in that it is only relating to overnight rates in US dollars, and it's secured lending. Usually these uh, these so called repurchase agreements have a lot of collateral associated with them, and and because of that, it may not be as useful for contracts that are trying to find an appropriate benchmark for say year long or six month lending on an unsecured basis. And that's going to be one of the biggest adjustment costs in

trying to trying to adapt to the new rate. Well, how complex will the transition be from live or to sofa? Well, in some ways, it will be very very quick, particularly for short term borrowing. I could certainly imagine the benchmark rate uh, you know, and it's already happened to some extent, has already transitioned within some private contracting over to the sofa rate, and and that will be a pretty easy

transition to make. I think it really is when you're talking about maybe longer term instruments in which you know, the short term rates and the long term rates don't necessarily line up as well, and maybe there's more volunteer volatility in the yield curve, or there the difference between long term rates and short term rates, that you'll start to see a little bit more of a resistance to

pick up these uh these uh, these new benchmarks. You have to remember, however, that by one the British regulators, the Financial Conduct Authority, is going to stop requiring firms to to make reports into liebor. So it may be that by the time we hit that point, everyone's going to realize that the jig is up and they're going to have to find some other form of of benchmarking rate. This is a reliable one is particularly good for short

term UH instruments. It is not going to be as good for longer term instruments, but it maybe the best thing that's around. So the Federal Reserve began publishing the rate today, what happens next and how long? Yeah? Yeah, So so a lot of a lot of this is up to private contracting, right There is a lot of private contracts out there right now that are built on Liebor as their benchmark. Great, and that's gonna involved, and that's got a lot of network x ternalities associated with it.

People are used to those sorts of contracts. Uh. Some of those uh, some of those entities that author those form contracts, such as ISDA, are going to maybe want to adapt their contracts to say, here's a new template that you could that you could use SOFA as the as the benchmark rate for And then people are gonna have to start adopting that as a benchmark rate. To

some extent, that's already started to happen. And my guess is that with a greater notoriety and greater sense that other people are using this rate, people are gonna have greater degrees of comfort in in uh, in adapting to it itself. One has to remember that when labor, you know, liborar hasn't been around forever as well. It's only been around since the since the late nineteen eighties, and it really did pick up steam relatively quickly. This industry is

now much larger of financial contracting. The hinges on some type of a reference benchmark, and so there's really going to be a perceived need to find something that works well. And my guess is that the shorter term instruments are

going to migrate to it pretty quickly. Longer term ones may hold off for a while just to make or that that you know, their their simulations and modeling make it look like they're not bearing risks that they were unaware of, and they're they're slowly going to come on board. And by the time that that the sea stops collecting live or information, you know, in about three years, um, you know, most people will have made this transition. Now,

could works go ahead? No? I was I was going to ask you, is this is libor is um so for the only benchmark in the running, let's say, or are there other countries suggesting alternatives? Yeah? And there are other countries suggesting other alternatives in There have been several alternatives that have been bandied about, and to some extent those are still being bandied about. My sense is that that some form of short term repo or other or commercial paper rates are the ones that are most likely

UH to to have legs. UH though there are some UH financial authorities that are considering using the rate paid for government borrowing. That was one of the candidates that that the the Alternative Reference Rate Committee considered. One of the reasons they decided not to go with UM with UH. You know, something related to say US treasuries or other types of bank borrowing is that sometimes those are safe havens in times of gotta stop you there, Eric, we

will come back to sofa. I'm sure many times. That's Eric Tallely of Columbia Law School. Jurors are getting a rare look at Washington's political intelligence industry at the trial of consultant charge with passing government information to hedge funds, the first trial of its kind. The prosecutor says, is a case about greed on Wall Street and corruption in d C. The defense attorney says, New York is the city that never sleeps, and d C is the town that never shuts up. My guest is an expert in

Insider trading. Peter Henning, a professor at Wayne State University Law School, Peter David Blaze Act. The console is on trial with the former government employee who allegedly tipped him and the two partners of the hedge fund Dear Fielm Management. Tell us a little about the charges. Well, this is one part of the case is a standard insider trading case, so they're accused of securities fraud wire fraud, which is

also usually brought together with this. Another part of the case is interesting though, that the defendants are also charged with illegal conversion of government property. In other words, that uh Warral, the government employee essentially improperly took government information and then passed it on to the others. This is

like receiving stolen property. And so this is something you normally don't see in an insider trading case, and I suspect prosecutors have this charge in their essentially as a backup in case the insider trading part falls apart. Why is the insider trading part more difficult for prosecutors than the typical what you call the typical Wall Street insider trading cases that we've seen so much of in the

Southern district. Right. Well, usually in the typical insider trading case, it's corporate information that is being taken from the company. So in earnings announcement, a deal, perhaps a new invention, something like that that's gonna bump the stock up or down. Um, what this is is about information about how the government was going to reimburse for Medicare and Medicaid procedures or procedures in which doctors would be reimbursed. And typically that

type of information seeps out in advance. So an interesting question here, and that's what the defense attorney referenced. That wasn't really confidential information. Corporate information is usually kept confidential, at least until the company has to disclose it to everyone. Government information has a way of washing through the system. And you know, this idea of Washington is the culture

of leaks, and everybody talks in Washington. How far do you think that defense will take them because we've seen cases, for example, the Jesse Lit back case, the bond trader. Who's that everybody does this and it doesn't always work, right, Yeah, everybody does it. It usually is not a very good appeal.

It didn't work in kindergarten. It's probably not going to work in a federal court, but it'll be interesting to see how a Manhattan or or a New York jury responds to a description of how Washington works and what

we know Washington is filled with leaks. But there's also an aspect here that there is a level of transparency that we expect out of the government, that the government, leaving out the national security area, the government doesn't suddenly announce a complete change in policy that this is usually signaled, And so might it be that this really wasn't the kind of market moving information that we see in the

corporate context. If you're going to announce blockbuster earnings or a drop in your earnings, that usually has an effect on the stock. This was about something a step removed, even from the companies that had a stake in the amount of government reimbursement through Medicaid and Medicare. The government star witness is a former deer Field partner who pleaded guilty in as cooperating. So that's a tough witness for

the defense. Are they admitting a lot of the facts here and going with the this isn't confidential line, or are they disputing Well, I think and this is typical and most insider training cases. They're admitting a lot of the facts. They all admit the deer field. The hedge fund investors say yeah, we bought the shares um blaze Ack said yeah, I passed along this information. So really what this is a fight about is figuring out um was it confidential and was it material information in other words,

important to the market. And then also you have another aspect here too with the two hedge fund defendants. Did they know about the benefit that Blazak passed along to war Out the government employee. That's part of the famous Newman case that remains viable that Tippy it it's called a downstream Tippy has to know about the benefit or at least that there was a benefit provided to the source of information. So that's probably going to be another fight,

at least for those defendants. So government has a lot of issues it has to deal with in this case. So I don't think this is an easy one. They have a good record in insider trading cases, but it'll be interesting to see how this one plays out. Depending on how this one plays out, does this indicate that federal prosecutors are going to trade sending Wall streeters to prison for trading on inside information to taking on Washington's

culture of leak. Well, that that's interesting. Uh, this is the first one, and it's what's called a political intelligence firm, is what blazek ran Um? Are we going to see more policing in this area? This may be the start, but this also may just be the best case that they have, and they're probably hopeful that it sends a message to other political intelligence firms. You had better be careful,

Peter about a minute here. But the problem seems to be that many government employees go on to become consultants, and their clients expect them to leverage their former colleagues to get heads up on information or other kinds of information. Isn't that why they're hiring them? Oh? Absolutely, I welcome to the revolving door. That I mean, we see it in every agency. An agency, I'm quite familiar with the SEC.

High level people routinely go to law firms U And one of the things that you sell is your access um not in formation, but I can get to the people who have information. Um. Will this stop the revolving door? No, but it might put a little bit of a chill into companies that are looking to hire people because they want their rolodecks. It's it's a fascinating case and we are going to follow it closely with you. That's Peter Henning.

Thanks so much, Peter. As always, he's a professor at Wayne State University Law School and expert in the area of insider trading in criminal white collar criminal law. Thanks for listening to the Bloomberg Law Podcast. You can subscribe and listen to the show on Apple Podcasts, SoundCloud, and on Bloomberg dot com slash podcast. I'm June Brosso. This is Bloomberg. Yeah.