Another post-Libor rate aims to clear Iosco bar

Credit-sensitive benchmarks have a tough gig.

A year ago, global standard-setter Iosco blasted two credit-sensitive rates for puny liquidity in underlying markets, ordering them to “refrain from any representation” that they are compliant with its principles for financial benchmarks.

Now, the provider of a third rate has hired a consultancy to give an imprimatur to its offering.

A report from IBM’s consulting arm, Promontory, initially flagged a series of shortcomings in the design of the across-the-curve credit spread index, or Axi, which tracks banks’ marginal cost of funding.

But after remedial work, Promontory gave the index a clean bill of health.

There’s a hitch, though.

The assessment covered only three out of the 19 Iosco benchmark principles: benchmark design, data sufficiency, and transparency of benchmark determinations. Promontory’s report was also a “limited assurance review” – in other words, its findings should be treated with a degree of caution.

And the consultancy’s conclusions were carefully worded. It said that Axi’s owner and administrator “appear” to have reasonably addressed the initial deficiencies and, thus, the three Iosco principles “appear” to be fully implemented.

It’s not clear whether Iosco will intervene – a spokesperson for the standard-setter did not respond to a request for comment. But with last year’s decree directed at both administrators and auditors of the previously reviewed rates, it is perhaps understandable that Promontory’s report stops short of a direct statement of compliance.

The assessed principles – 6, 7 and 9 – are critical. The same trio was singled out in Iosco’s evaluation of Libor replacement rates last year. The report did not name the credit-sensitive rates in question but the Financial Stability Board had previously confirmed they were Bloomberg’s Short Term Bank Yield index (BSBY) and the Ameribor index published by American Financial Exchange. Iosco’s conclusion that the two rates were not compliant with its principles overruled the findings of two US audit firms, including EY.

Iosco’s gripe is these rates are constructed from unsecured bank funding transactions, which are “not sufficiently deep, robust and reliable” for Libor replacement rates.

Axi’s backers say their index is different. For a start, the rate is being touted as an add-on to the secured overnight financing rate, or SOFR. Rather than splitting liquidity between maturity buckets, transaction data is combined into a single rate, which is scaled to produce term fixings. Input data extends beyond the short-term funding markets criticised by Iosco to include bank debt out to five years, though this long-term element accounts for less than 4% of transaction volumes.

Still, Promontory’s narrow assessment has raised eyebrows.

“While those three principles are extremely important, I’m a little surprised they limited the scope like that,” says a benchmark specialist. “Other benchmark administration firms looking to comply with Iosco do not limit the scope like this.”

Axi was devised by a group of academics including Stanford University’s Darrell Duffie, who chaired the Financial Stability Board’s original committee on benchmark reform and has held advisory roles on Federal Reserve committees. It was developed for commercial use by SOFR Academy and is administered by Invesco Indexing.

Marcus Burnett, chief executive of SOFR Academy, says the review should be considered in conjunction with a broader appraisal of the administrator’s Iosco credentials. An annual audit by PwC rubber-stamps Invesco Indexing’s adherence to all 19 principles. This evaluation categorically excludes Axi and FXI, though Burnett says the outstanding principles largely relate to broad administrator responsibilities such as governance and oversight rather than the benchmarks themselves. 

“The benchmark administrator was already publishing their indices in alignment with the principles. What we wanted was a dedicated, deep-dive review on the three principles that relate to the benchmark’s robustness, representativeness and transparency,” says Burnett.

“In combination with the broader reviews PwC conducted, we can say Axi and FXI are developed, published and administered in alignment with Iosco principles.”

Rival benchmark, Ameribor – which has been adopted by some regional banks for lending activities – removed all Iosco references from its materials following last year’s Iosco ruling, despite having a compliance statement from a top five US audit firm. It is understood American Financial Exchange continues to work on future compliance, though it may be unable to make any further alignment claims without a reversal in Iosco’s position.

The damning verdict proved the final straw for BSBY, which will cease publication in November after Bloomberg saw limited commercial scope for rates lacking the Iosco hallmark.

Even if potential users do conclude Axi has ticked all 19 boxes, and assuming Iosco refrains from further intervention, some say it may be too late for credit-sensitive rates.

Since US Libor’s mid-2023 demise, industry participants have adapted to SOFR in its various forms – overnight, averages and term SOFR – without major hitch, lowering the volume on calls for credit sensitivity.

BSBY’s demise also proved costly for some supporters. Bank of America took a $1.6 billion hit in its fourth-quarter earnings as a de-designation of BSBY derivatives resulted in the loss of hedge accounting privileges for some transactions. Texas-based Comerica took a $91 million hit from BSBY-related transactions.

“I think there will be reticence to use any alternative credit-sensitive rate because of what happened to the BSBY index,” says a consultant working with US regional banks. “The feeling that regulators may not permit such a rate to exist is the main takeaway.”

Burnett says demand has not ebbed.

“We continue to receive feedback from regional banks and larger banks, as well as non-bank financial institutions, that a credit-sensitive element that’s acceptable will be very helpful for asset liability management, and in providing valuable market information and price transparency,” he says.

Burnett adds that banks remain exposed to substantial risk through SOFR-only lending.

“Revolving lines of credit are the dominant form of lending in the US, and the concern is that next time something bad happens there could be a run on certain bank credit lines, as borrowers with SOFR-only loans don’t have any disincentive to draw down. That has some significant adverse implications for the US economy.”

Whether or not dealers will have unfettered access to those benchmarks is still far from certain. 

Editing by Alex Krohn