The road to replacing Libor: a finance legend's alternate path
After Richard Sandor sold his carbon exchange for almost $600 million in 2010, the Chicago trading legend set out to find another big idea.
He’s good at that.
When he was an economics professor at the University of California at Berkeley, a half-century ago, Sandor drafted one of the first plans for an all-electronic market, around the time Wall Street was drowning in paper. Then at the Chicago Board of Trade in the 1970s, he was a driving force in extending derivatives beyond corn, soybeans, and other tangible commodities. Now futures let traders hedge or speculate on financial intangibles such as interest rates and the S&P 500. Indeed, the U.S. Treasury bond futures that Sandor got going in 1977 turned into such a valuable franchise that the Chicago Mercantile Exchange paid $11 billion to buy the Board of Trade in 2007.
A decade ago, when Sandor was looking for his next big thing, he thought it would be water. “It’s going to be the commodity of the 21st century,” the 78-year-old recalls in an interview at his office in Chicago’s Wrigley Building. But in 2011, news about the London interbank offered rate, known as Libor, caught his attention. A scandal was roiling the heart of global finance, the benchmark for rates on mortgages, student loans, and a gazillion other things that together are valued at hundreds of trillions of dollars. “Libor is going to lose its preeminence as a benchmark,” Sandor remembers thinking. “Let’s bet the ranch on that.”
And so Sandor—whose nickname “Doc” was on the yellow badge he wore in the trading pits, a nod to a doctoral pedigree that stood out on the rough-and-tumble floor—created his own rates index, dubbed Ameribor. His aim was to fix something he thought was wrong with Libor from the start. Traditionally, Libor was derived from a daily survey of large banks, which provided estimates of how much it would cost them to borrow from each other without putting up collateral. It turns out a bunch of the banks manipulated it for years, fudging numbers to serve their interests.
The problem, Sandor says, is that it wasn’t based on real transactions. “It’s not a free market, where prices are determined by supply and demand,” he says. “It’s not the Chicago way.”
Sporting black-and-teal eyeglasses and a fedora, Sandor stands out in Chicago’s financial community. With his wife, Ellen, who is an artist, Sandor has amassed one of the world’s top private collections of photography. Some 200 of their pieces adorn the walls at the American Financial Exchange, an electronic marketplace where small, midsize, and regional banks can lend and borrow short-term funds, and where Sandor is chairman and chief executive officer.
His efforts to create a new interest-rate benchmark initially elicited eye rolls from experts. After all, the Federal Reserve was already several years into its campaign of holding rates at zero. Institutions could access cheap capital in the debt markets, reducing the need for interbank lending, which Libor is supposed to measure.
But two years ago came a huge opening for Sandor. The head of Libor’s overseer, the U.K. Financial Conduct Authority, said it would stop making banks contribute estimates to the index by the end of 2021. The move would wean the market off the benchmark, though it would stop short of killing it.
Regulators around the world rushed to find replacements. The U.K. opted to enhance an existing benchmark called the Sterling Overnight Index Average, or Sonia. The U.S. decided to create a rate based on overnight repurchase agreement transactions secured by U.S. Treasuries: the Secured Overnight Financing Rate, or SOFR. Intercontinental Exchange Inc. (ICE)—which happens to be the company Sandor sold his Climate Exchange Plc to in 2010—made its own alternative: the Bank Yield Index, a benchmark that is a rolling five-day average of term funding transactions by Libor panel banks. In addition, ICE Benchmark Administration, the current operator of Libor, has evolved the benchmark’s methodology so that submissions are based on transactions to the greatest extent possible.
It’s unlikely that any of these will ever match Libor’s predominance. Although the Alternative Reference Rates Committee (ARRC), a collection of market participants and regulators engineering the transition in the U.S., is pushing SOFR as the heir, many are wary of adopting it. Libor has long been used as a barometer of stress in credit markets, but SOFR wasn’t designed for that. It only tracks overnight repurchase agreements and lacks a forward-looking curve with tenors extending beyond a day, though Fed staffers have issued a paper about inferring term rates from SOFR futures prices. By contrast, Libor has rates ranging from overnight to one year.
The Basel, Switzerland-based Bank for International Settlements, which serves as the bank for central banks, said in March that a one-size-fits-all alternative to Libor may be neither feasible nor desirable. And that’s what Sandor is betting on. “Multiple benchmarks and choice, as an economist, is good for the market,” he says. “What is this love affair with a single index?”
He’s going big by aiming small. There’s about $18 trillion in the U.S. banking system, according to Federal Deposit Insurance Corp. data. Roughly half of that is stashed at the largest banks. That leaves $9 trillion or so in the hands of thousands of smaller banks. And Sandor thinks half of that money—around $4.5 trillion—is held in variable-rate products that need a new benchmark to reflect their true costs.
Ameribor is a daily rate based on the volume-weighted average of transactions in the overnight loan market between preapproved counterparties, which include banks, broker-dealers, and private equity firms, on the American Financial Exchange.
For someone accustomed to schmoozing finance professionals in London, New York, Paris, Shanghai, and Singapore, selling institutions on Ameribor required a different itinerary. Sandor found himself meeting with bankers in smaller towns, such as Tupelo, Miss. (population 38,206), and Bentonville, Ark. (population 51,111).
Now, he can even point you to the best barbecue joint in the U.S.
Ameribor’s chilly reception was similar to what Sandor remembers hearing when he evangelized for financial futures decades ago. “It’s a stupid idea. Interest rates don’t fluctuate,” he says.
But when the Fed convened ARRC to find a new rate in 2014, Ameribor suddenly seemed less outlandish. In December 2015, Sandor’s American Financial Exchange introduced the interest rate with a handful of banks at Cboe Global Markets Inc., the market operator formerly known as the Chicago Board Options Exchange. The platform hosts more than 160 companies, mostly banks, and just had a record week, as $13 billion traded on Sept. 16-20 amid turmoil in the repo market.
Frost Bank, founded in the 19th century in the back of a San Antonio store selling supplies to frontier Texans, took part in the first overnight loan transaction in 2015 and still uses Ameribor all the time. “It is the best proxy out there for where we can incrementally fund ourselves in the short-term space,” says Mark Brell, an executive vice president at the bank.
AFX introduced Ameribor futures, also at Cboe, on Aug. 16. That’s right out of Sandor’s playbook from 1977, when the Chicago Board of Trade began offering contracts on the 30-year Treasury bond. He says the first step is “the building of the cash market,” proving that it’s volatile and that there’s a need to trade. The next step is building a hedging tool, “because that’s the natural evolution of markets.” Those 30-year futures began trading when the U.S. had about $550 billion of debt outstanding. The government sold more than that in the month of August 2019. Today, volume across the Treasury futures franchise (which has expanded to include almost every maturity) has exploded as the debt has swelled to $16 trillion.
The futures launch is just the beginning of Ameribor’s influence. To expand, Sandor and his team will keep meeting with bankers, academics, accountants, and lawyers, trying to prove to them that the benchmark is a true representation of interbank lending costs. And that means more time traveling through tiny towns, helping the smaller banks who finance “the milk farmers and whatnot to the burgeoning tech sector in Indianapolis.”
Oh, and the best barbecue?