A futures pioneer bets on 'Ameribor' as U.S.-dollar Libor successor
Richard Sandor helped develop the first interest rate futures in the 1970s as chief economist at the Chicago Board of Trade; in the 1990s he founded the Chicago Climate Exchange, the world’s first exchange to facilitate the reduction and trading of greenhouse gases.
Since 2012, he's been working on what could be a successor to the London Interbank Offered Rate for U.S. assets: an interbank lending rate called Ameribor. This homegrown benchmark is already being used by 89 community and regional banks to price wholesale, unsecured funding between institutions in place of Libor.
Ameribor does what Libor is supposed to do: represent the true cost of funds. It is set by open-market transactions on the Chicago-based American Financial Exchange (AFX), offering what Sandor describes as a “fully transparent” benchmark using “actual transactions” under trade regulations of the Chicago Board Options Exchange.
“This is a rate just like a stock price is determined by continuous order flow, between lenders and borrowers that occur during the trading day,” said Sandor, who is also a distinguished lecturer at the University of Chicago School of Law.
Now that Libor appears to be on its way out, Sandor and his team are promoting Ameribor's expansion for further bank borrowing as well as for use in futures and options contracts.
In Sandor's his vision, Ameribor could be among several benchmarks – including the Secured Overnight Funding Rate (SOFR), published by the New York Fed – that will be used in place of Libor should that latter disappear after 2021 when panel banks will no longer be required to submit quotes for its publication.
Sandor recently spoke with Asset Securitization Report about the development of this new index and its potential as a benchmark for all kinds of assets, including asset-backed securities. An edited transcript follows.
ASR: Explain why the American Financial Exchange wants to develop a new benchmark?
Sandor: In 2012, when we trademarked Ameribor and filed our first patents, we had three hypotheses. Hypothesis one was that zero interest rates were not sustainable. They were a policy born out of a crisis, but not sustainable and that interest rates would normalize. In that normalization process, a poll of a benchmark was not the best way to do it, and that Libor would be criticized and would have to change dramatically or fail.
The second hypothesis – the Fed funds market had disappeared, and the role of a government being the sole lender and borrower would eventually disappear. Interest on excess reserves (IOER) would be lowered while peer to peer lending and electronic exchange with interest rates competitively determined would have a high-value proposition.
The third hypothesis – broad representation maximizing the true cost of funds for community banks, regional banks, domestically oriented banks in general. These are the banks that disproportionately lend to small businesses, the mainstay of job creation in America.
What are the next steps for Ameribor?
We have several banks that are interested in adopting, on a pilot basis, Ameribor as the benchmark for commercial and industrial loans. We’ll be working on trying to do that in the next quarter. As Ameribor gets accepted and as we build its credibility, a pilot program on interest-rate swaps based on Ameribor will emerge. Then we will launch a futures contract and then option contracts which will facilitate the hedging of swaps, swaptions, etc. This will provide instruments tailor-made for bank asset-liability management.
What’s given you the confidence you can get wider acceptance and adoption of Ameribor?
We feel that this represents to domestic banks a tool which represents unsecured borrowing and lending rates, and we feel that would be quite different from SOFR, which is a fully secured, risk-free rate not that applicable to bank lending. We have several people in both the banking side and the investment side that would like a floating rate truly tied to bank funding costs.
And based on transaction data?
Absolutely. Actual transactions, fully transparent and regulated by an SRO, the CBOE. Anti-manipuation rules, compliance, no spoofing. It will be a private-sector rate that is independently calculated and the compliance department of the CBOE will oversee that the trades are conducted according to the anti-manipulation rules specified and contained with the Ameribor rulebook. While Ameribor will be a weighted average of all trades during a month, the individual transactions can ultimately be audited.
How is the rate derived between the two counterparties?
The same way that Apple stock is. There are bids and offers between 7 and 5 central time, and it’s a continuous market like derivatives and equities. When bids and offers cross, the transaction occurs. It’s not preset. That’s the important point. This is a rate just like a stock price, bond price, or financial future that is determined by continuous order flow between lenders and borrowers that occur during the trading day.
How would it transition into asset-backed securities, especially with so many outstanding long-dated maturities in the market (past 2021)?
Ameribor or SOFR-based assets that are floating rate would be easily placed in asset-backed securities the same way that is done with Libor today. Those floating-rate assets could then be swapped into fixed rates with liquid hedging mechanisms as Ameribor futures and options emerge.
In regard to Ameribor’s application to securitizations, what asset classes would you say it is most suitable for, and why?
It will likely first start with commercial loans. Our member banks may identify customers to use Ameribor in new loans. The same may happen when another financial player wants to a swap based on Ameribor. The adoption will be gradual – especially as the market becomes more robust and grow after the launch of futures and options.
What are the tenors offered on Ameribor?
Right now, the main tenor is overnight. We are preparing the launch of a 30-day rate.
Like Libor’s six-month and one-year benchmarks, will Ameribor eventually develop longer tenors?
I don’t think so, because I think if you have an overnight, 30-day, maybe a 90-day, you can swap or use futures to synthetically create longer tenors. That’s what the Eurodollar futures market does. If you have a 30-day or a 90-day or both, you can list them out three years and synthetically create a one-year or two-year rate. If you have an active and successful futures market, you don’t need a one- or two-year rate because it’s redundant.
If ICE Benchmark Administration decides to continue publishing Libor past 2021, could Ameribor co-exist in a market still dominated by Libor?
Absolutely. That in fact may be where it ends up, where you have three choices. SOFR, Ameribor and perhaps a modified Libor. There will be financial institutions that want to use SOFR for the derivatives market, Ameribor for domestic banks or even Libor for the multinationals.
Are there use cases being developed to convince big banks to begin lending on the higher Ameribor rate?
Yes, we started working with community and regional banks. Now we are moving to the super-regionals, and it will only grow. It could be a tool for any banks if it is stable and hedgeable.
Why would they choose Ameribor so long as the overnight or 30-day Libor is lower?
Multiple benchmarks serving different market niches are a good thing. Secondly, banks make their money on what they charge above a benchmark, so the issue of which benchmark is higher is less important. I would also point out that Ameribor is not really higher except when international currents distort Libor. More important, banks will be drawn to a benchmark that is stable and hedgeable.
What makes Ameribor’s basis as an U.S.-based rate important for borrowers and lenders?
It is a more realistic depiction of their actual cost of borrowing. It can become more of a bellwether because it takes into consideration transactions from a wide array of institutions in various parts of the country, doing business in different regions, which have their own characteristics and different economic factors.
How would Ameribor avoid the volatility that’s occurred with Libor?
A broad enough market, as we have designed this to be, compresses that volatility. If you have a limited number of players, you’re likely to have more volatility. And that’s true in finance throughout. Thin markets tend to be volatile, and more liquid markets, other things being equal, tend to be less volatile. Thinner markets have wider bid/ask spreads, and therefore more volatility. We currently are running at very narrow spreads.
Now if the underlying dynamics cause volatility as it did in 1979, or 2007, it might suppress it a little but it’s not going to be a cure; it’s just a way to have an efficient market so that there is a minimization of spikes which don’t reflect underlying supply and demand. And if a market is transparent and regulated, it’s more likely to reduce volatility, other things being equal. In our case, regulation includes self-regulation via AFX and our compliance partner, which also has anti-manipulative rules.
What are challenges facing in further building up liquidity in and adoption of Ameribor-based transactions? Just reluctance to change?
I think it’s the change that I faced over the last 40 years. And that is my experience is it takes a decade for real adoption. I started working on interest financial futures in 1969. We launched the first futures six years later [through the Chicago Board of Trade] ... and I would say it took a decade through the Volcker tightening in the late ‘70s. So it’s a decadelong process and we’ve got six years in [Ameribor] by now.
I liken it to an industrial innovation. If you look at the PCs introduced in 1975, it took five or six years for them to be used [widely]. It took 20 years to birth the Web. And 30 years to get the iPhone out.
We are also trying to be innovative about liquidity. For example, we have been accepting nonbank members, as lenders only, to expand the breadth and depth of our exchange.
You have a new book on blockchain. Do you see a connection with the transactional-based Ameribor rate adoption with wider-spread use of technology such as smart contracts?
Unambiguously yes. In fact, the American Financial Exchange is developing blockchain applications for benchmarks.
What specific blockchain applications is AFX working on?
Initially, the ability to store data that goes beyond the standard of time, quantity and price on the blockchain is of great interest to us and our members.