The Case for AMERIBOR As The Replacement for LIBOR

that we finally working through all that. You know, our first episode we sort of talked about the problems with librar pre financial crisis and post financial crisis, and then in the second episode we talked a lot about the transition away from library and how that's going. In this episode, we are going to talk to someone who's actually actively trying to come up with an alternative reference rate. Yeah.

It's interesting because I know that there is a very big push a foot to move you know, as we've talked about from libor over to so FUR, and they're all kinds of efforts going on for that front. But I guess that is not the only theoretical alternative approach. Yeah, exactly. So, even though there's this regulatory push towards the security overnight financing rate or so fur there are well, there is the potential for alternative rates to enter the market, and

we have the perfect person to talk about this. We're gonna be speaking with Richard Sandor. He's the chairman and CEO of the American Financial Exchange, also someone who occasionally is referred to as the father of financial futures, has a lot of experience in the derivatives market and has well invented quite a few contracts over the years. So again, the perfect person. I'm really looking forward to this. Okay, let's bring him on. Richard, thank you so much for

coming on offts. Oh, it's my pleasure. Thank you for the invitation, and I'm happy to be here with both of you. Thank you, thank you. So I gave a little bit of an intro just then. Um, but it's kind of hard to summarize your career because it's quite expensive and you've done quite a few things. Can can you try to summarize it in a in a nutshell for our viewers, viewers, for our listeners. I should say,

it's really hard to talk about yourself. I leave that to others generally, But let's say I'm a serial and the inventor and the financial innovator. I get it wrong a bunch of times and then get it right too. So I've spent forty five years trying to observe capital markets and see what instruments can be developed to minimize transaction costs and achieve social objectives. And Library and its successors fit into that. And like most inventive activity, there's

a spark. And we had sold our last exchange, which was a series of market based solutions to global warming, two ice in twenty ten. UM. It was very successful. Our investors made seven and a half to fifteen times their money between oh three and ten. A sale price was six hundred million. And we had developed exchanges in North America, the UK and China, and we reformed the incubator, which is something called the FP because we were looking

for new markets and we started to look at water. UM. We had a contract with the state of New Mexico, California looking at China because we thought that water would be and still do think the commodity of the twenty first century. I picked up a newspaper in twenty eleven UH and read that the Royal Bank of Scotland fired four people for manipulating library. Uh called the team in and even I know it takes two to manipulate. So if there was one, then there was going to be

a second, and we by no really expanded too. Would go to four, four, would go to eight, etcetera. And that ultimately we thought that there would be a demise in library, it would end, and that we would set off on a ten year odyssey to develop a replacement to librar. Library was unusual and in that it was the only asset class that I knew about that had a single benchmark, all because of alone in the sixties to the shah Iran. If you take a look at crude oil, it's got w t I, it's got brand,

it's got Dubai, it's now gonna Shanghai. If we look at the equity markets, they have Nastack SMP, Dow Russell Value Line, more stock indexes than there are stocks, and the same with fixed income. So what is this anomaly called library? And how could we have hundreds of trillions dollars tied to a pole that would be like electing the president of the United States based on the Wall

Street Journal poll. It made no sense whatsoever that it was the only benchmark, and it wasn't even market determined. So we set out and said, let's develop something that is everything that Libor isn't. Let's make it transparent, let's make it regulated, let's make it based on transactions only, and let's make it American. London has lib Or, Europe as Europe, or even Hong Kong as UH high bor. How could it be that the world's largest economy didn't

have its own benchmark. So UM I got on a plane and instead of going to London, Parish, Shanghai, Hong Kong, uh and Vienna, etcetera, I ended up in Bentonville, Arkansas, Tupelo, Mississippi, San Antonio, Texas, Green Bay, Wisconsin and visited a hundred and twenty five small banks with my colleague. So if it was going to be a benchmark, it would be one that was based on American banks overnight, unsecured lending to each other. We were naturally viewed with some skepticism.

Interest rates for zero. People said library is never gonna go away. You don't understand, Dr Sandor, this is the bedrock of all finance, and your climbing up a mountain and you need to go back to Chicago, because not, that's not the way it works. We felt quite opposite, and actually as a contrariant and as an inventor, that was really bullish because everybody thought that there was no

need for it. And oftentimes in my experience, whether it's financial futures, the derivatives, everybody said no need for it. Whether it was acid rain and the mark and no need for it, catastrophe bonds, no need for it, climate change no not happening, no need for it. So whatever small success I've had, it's been where the lights and beacon of the industry has told me that there's no need for it. So talk to us about your approach.

You mentioned the sort of absurdity that the world operated on a single benchmark, even though most things, whether it's doctor or multiple benchmarks all around the world. What is it about the way that UM your index would be constructed that's a better for use. Why regionalization is good but also less prone to some of the manipulation issues that of course accelerated or caused live worth of mine

great questions. So we again we thought that we would stay away from siffy UM the systemically important financial institutions, and we would go to recruit the five thousand by inks Um that were non citfies and not go after the fifteen Ciffy. So our market was going to be five thousand banks that have approximately nine tribuon and assets about half of that and floating rate, and that would

be Regional's mid sized community banks. And if we had breath as well as depth that the competitive markets like wheat and soybeans and gold, et cetera, that were regulated and we're transaction based, manipulation could not occur. And if it occur, if it was regulated, we had policing and enforcement powers. So we hooked up with sea Boat. We said, here's our algorithm, here's our benchmarks. You have a big compliance department, you're an s R. Oh want to securities exchange,

you own a commodities exchange. Why don't you be our compliance folks and take a look at every single transaction, have the complete tape, have a complete compliance thing, and we will make sure that that we are not manipulable and we will have to anti spoofing rules. Concentrations will be limited, we will be able to speak to anybody. We have a business conduct committee, we have a hundred and twenty five page rule book of students, and don't we have the ability to bring up a bank that

misbehaves and before a business conduct committee. We know how to do this. So we set in place all of the things that traditionally regulated and transportent markets perform. So we started with four banks, we traded thirteen million a day. We're up to a hundred and forty three banks, another twelve hundred correspondents, so we have about thirty percent of

America's banks. We trade two and a half billion dollars a day after four years, and we have eighty participants in any given quarter a month, so we are deep and we are broad. We also brought in iasco because we thought it was important that we get independently audited with regard to liquidity, concentration, etcetera. So an independent audit was accurred by a major accounting firm that said we were AYASCO compliant. When we hit a billion dollars a day,

we went and got to see FDC approval. They have to make sure the index is viable before they allow you to trade a future. And we have broadened the market from not only hundred forty three banks, they include all of the big regionals Regions, Northern Trust, the fifth Third, et cetera, fifty percent of the banks just under between five and sixty billion, and the twelve hundred community banks.

We also have Jefferies, the Progra dealers, insurance companies like Northwestern Money Managers, Goggenheim just joined, and now we have companies like John Deere. We feel that a transparent, regulated market that has eighty participants, that does billions a day is an adequate benchmark, and how you can see the tape.

Every trade is transparent, it can be monitored, it can be audited, and so we feel we've just taken an age old tradition that exists in Chicago, provide many buyers and sellers of a broad commodity financial instrument, and the rest will take care of itself. Richard, I want him to go back to UM. I guess this's the notion that you had that you you didn't have to have a reference rate, a sort of one size fits all

reference rate. You could have shades of it. I have maybe a stupid question, but some people would perhaps argue that one of the good things about having a benchmark, a single benchmark, is the simplicity how would you respond to that idea? That's great. Simplicity is fine. If you're willing to roll the entire world economy on simpleness, then you get what you would get a total breakdown. You get simplicity, you just get a financial crisis. Why would

you want Look, well, I'm a professional economist. I teach at the University of Chicago. I've been doing it for forty five years. The economists don't know anything. Okay, we can't forecast, we haven't foreseen two major crisis is meltdowns things of this thing, there's only one thing you could probably get every economist. So if you go to China, you go to London, Roxford, you go to the University of Chicago, one and only one thing will everybody agree on,

and that is diversification. Right, that's you probably will get. Nobody will argue against diversification. R Right. It's the one thing we know. I don't know whether the market is going to go up or down, whether it's gonna crash, fall apart. We don't know anything in finance. And he can which other than choice and diversification is good. So obviously, um, you know, as you say, diversification of things are good. The dependent on a single librlar proved to be problematic.

As we set up in the intro, regulators are pushing for this Libel replacement SOFA which we've discussed based on overnight secured financing. Your you take a different approach. Can your vision, your index thrive in a world in which regulators are pushing for everything out or pushing for another

sort of universal Libel replacement? And can we have this sort of diversification even if regulators sort of have the specification we I don't think regulators are as singular in their attitudes and thought processes as the popular press with indicate. For the financial press, we have spoken to them and uh, that is that we've brief because this is how we operate. We for the last five years, we go down in Washington, we brief the FED, the O C C B F

D I C B SEC, that's the FDC. And when I say to them what I am sharing with you, that there should be a free market for ideas and competition for ideas, not one, not a singular one, said that's a bad idea. Okay, they have not said they are officially neutral. Um, we already have our premise from twenty eleven being validated. We got so Fur, we got Sonia, and we got Tona. We did Esther. We're already breaking down the idea. It a simple idea. Now, why would

you have only a risk re rate. You need a risk rate because in fact, what we've learned in the last two crisises, there's a flight to quality and interest rates between government guaranteed paper and private uh borrowing non public diverge on crisis is and secularly when there's a recession. So you need a credit component in an index. We

are the only index that has a credit component. Five thousand American banks want to develop assets which reflect their borrowing costs so they can match the two in an asset liability management process. So if you want to make the banking system stable, you should develop floating rate assets that reflect the floating rate costs. And for five thousand American banks, the risk free rate is fabulous. We believe in So for we think it's a great thing, it's terrific.

For the money center banks it doesn't fit and the five thousand small banks. Getting back to my opening comment about social purpose, we had Jeremy Stein with who is the chair of the Harvard Economics Department. We funded a lecture at Northwestern two years ago, and it's unambiguous that that these midsize, regional, and small banks disproportionately create jobs in America. This is a critical time in our economy

in the world. Why would one be against the institutions that function and provide financing to America's businesses, small businesses which disproportionally create jobs. I don't get that opposition. It's like being in a Madrid painting. It's surreal. Richard, you're talking about the importance of having a credit component in uh this benchmark reference rate. I wanted to ask you, I think the loans that you're looking at include not just loans between banks, but also between broker dealers and

private equity as well. UM. I think that's right. Could you maybe talk a little bit about why you thought it was important to include those entities as well. Yeah, I I think the job is not only to create liquidity in the banking system, but it is the bridge the market between the banking system and the capital market. And if you have Serberis or Jefferies or John Deere or Northwestern Mutual that also resources of liquidity, then you bring to bear the power of more and more players

and greater breath to the market. So that's why we and all of those folks either have floating rate assets, they have asset liability management, they have capital market debt. So there's a natural nexus. And why libar was confined only to banks again is a historical accident. And if you wanted to design it was like saying, Okay, I'm gonna design a car, and it's going to be a two wheeler like a bicycle, because everything before has two wheels, and therefore I don't care if it's a car and

needs four wheels. It's like a bicycle, So let's make it a two wheeling. If you broke down almost anything you do, and if you look at inventive activity, you tailor it to what the more it needs and wants. And again we're struck by well, that's the way. You know, my grandfather used to do it, so I'm gonna do it the same way. Richard. Here's what I'm trying to still wrap my head around, because what you're saying makes a lot of sense that it doesn't necessarily benefit the

country as a whole to have a lending index. That's heavily skewed towards built around the big banks, that smaller companies, real economy companies like dear local banks key for job creation. All that big said, how does it in practice? How does the use of a mirrabor your index improve actual business functioning versus some of these other benchmarks when it comes to the actual writing of loans and other deals that need some index to be built up. Two ways.

I remember that the banks lend not based on a risk free rate, right, so if you if they are forced to create assets that are are risk free, then there will be volatility in their assets and liability. It will create uncertainty, it will reduce profitability, and therefore it will cause interest rates and profitability of banks to be lowered or account for the risks they take, and interest rates to be high for borrowers to reflect the increase

volatility associated with running the business. It's just like competition narrows. They spread between wholesale and retail prices. And it's true for supermarkets, car dealers, and it's true for interest rates. The more you get and the more the commodity becomes homogenious, the greater the benefits to the institutions. Through higher probability and to the consumers through lower costs. It's no different than any other commodity. Richard, you spoke a little bit

about adoption of a marabor. I guess I'm curious, what's the what's the next step for the reference rate to Joyce to Joe's point, when does like what would it take for adoption to really sort of take offer? What are you aiming for? Great question, You guys are super gonna smile on my day. So so in twenty eleven when we did this why experience, whether it was bond futures or as IT rate or anything, it takes a

decade to develop a market. So in twenty eleven we said this is going to take ten to fifteen years. Zero to two is toddler, two to five is kind of teenager and young adult, and five to fifteen is adulthood. We're eight years into the process. We got lucky when we said ten years that the and it was no judgment. It was a stroke of luck that we called for a ten year arise and just when live or ended one.

So we now have an it. This is true whether it's the personal computer you know, or or the iPhone these things take a generation to go. So we are now getting banks that are starting to price the loans that they make based on a Merra board fifty million, twenty million hred midion. They show on their graphs that they have a high correlation to the old librar, so

it's very easy days to educate customers. Equally, as we have adoption of floating rate, they're using a thirty day average because they can go onto Bloomberg, they can go on to you know, any vand or or marrabor dot net see the price of this perfect transparency, and they're

using a thirty day average. On June eight, we will launch a monthly futures contract on the thirty day average AMORBOR to reflect what banks are pricing loans to auto dealers in Memphis and small milk farmers in Wisconsin, me you know, hundred million dollar manufacturing companies in Arkansas. That's

how the loans are going to get priced. And then once that happens, we will UH and we are educating swap dealers now who already deal with these banks to swap floating to fix um and the swap dealers will be matched with a bank whose issue they floating rate loan to a corporate, they will develop a swap. The swap will be hedged in the futures, and that is

the final link in the maturity of the market. So as we see banks adopt marra bor is a benchmark, give it to corporates and small businesses on loans, then the banks go to either money center bank or a large bank to do a swap, and then that feeds the future, and then it's just a matter of replication, and we figure that's probably to to to five years we will see the ultimate broader adoption of a merabor as a benchmark um. And and again we see a

world in which Sonja so for a merabor. You know, there'll be a rate in Europe, We've already educated some central bankers there, uh, and there'll be a rate in China that that the whole benchmark will be disrupted and we'll see a whole family of different rates. Alright, Richard, Well, we'll have to have you back on in a few years to talk about what's going on with the marabor um in the US and also potentially some reference rates outside of the US as well. Thank you so much

for coming on off. This is my pleasure. Thank you. Your questions were intelligent, well thought out. Thank you very much. Thank you. That was great. His point about how there's no reason why you have to have a single benchmark, and it's kind of weird that for something as important as this sort of blending or interbank benchmark, that you only have a single one. I think that's really interesting.

I did too. I also think it's interesting this idea of wanting a credit component in the benchmark itself, because of course so FUR it's like, the idea is that really shouldn't be much of a credit component. It's secured and so on. But then of course, if you're going to build a loan on top of SOFA that you have to calculate a credit spread or some sort of market, the market will determined to spread on top of that.

So it'll be interesting to see if it makes more sense and to his point sort of a local regional company capital efficiency, if it makes more sense to have a benchmark that includes the sort of the credit conditions of the American economy overall. Yeah, and that risk free rate idea that's embedded in SOFUR, I mean that's very different to the original concept of live or and so from that perspective, you could see something like a Maribor

that does include that credit risk component. You could see that trading much more close lead to Libor then, so for I think, yeah, exactly right. Of course, even if you look at on our terminal right now, you see there's a pretty big noticeable spread between Maraboror and so for as it is right now. So, uh, it will

be interesting. Again. It sort of goes back to this idea of all of these things, whether we're talking about the reference rate, whether we're talking about a currency as sort of de facto social networks and or at least having big network effects. So obviously live Or had the ultimate network effect, but then it's sort of faded. But

we'll see. It'll be interesting to see if Ameribor can get enough traction so that people feel value and continuing to use it, which is a good reason to have Richard back any I don't know, six months or a year or something like that. Yeah, for sure. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway, and I'm Joe wasn't All. You can follow me on Twitter at the Stalwart. You should follow our producer on Twitter.

Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Leavie at Francesca Today, as well as all of the Bloomberg podcast that can be found under the handle at podcasts. Thanks for listening.