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Money Stuff: Libor Is Going Away for Real

March 08, 2021

Libor is canceled

I guess they were serious about that, huh:

Regulators kicked off the final countdown for the London interbank offered rate Friday, ordering banks to be ready for the end of a much maligned benchmark that's been at the heart of the international financial system for decades.

The U.K. Financial Conduct Authority confirmed that the final fixings for most rates will take place at end of this year, with just a few key dollar tenors set to linger for a further 18 months.

Here is the FCA's announcement, and here is one from Intercontinental Exchange Inc., which actually administers Libor. And here are two announcements—"LIBOR Cessation and the Impact on Fallbacks" and "ISDA Statement on UK FCA LIBOR Announcement"—from the International Swaps and Derivatives Association, which administers the market for interest rate derivatives.

One thing that is happening here is that ICE will stop calling up banks every day and asking them "at what rate can you borrow unsecured from other banks" and then using their answers to calculate Libor. That's what ICE does now, and what the British Bankers' Association did before ICE. It has become an increasingly untenable way to calculate an interest-rate benchmark, insofar as (1) the banks were lying about their borrowing costs for a while and (2) the interbank unsecured funding market is a lot less robust than it was back before the financial crisis, so it's hard to answer that question truthfully even if you're trying to. So, at the end of the year, it will mostly stop, though it will keep going for the main tenors of U.S. dollar Libor until June 2023.

Another thing that is happening here is that ICE will stop publishing Libor, sort of. Actually it will keep publishing some Libor rates for a while after it stops collecting them, though with an asterisk. (The asterisk says that the new Libors will not be "representative.") They will be "synthetic" Libor: Instead of being based on a poll of banks' borrowing costs, the new rates will be computed based on "a forward-looking term rate version of the relevant risk-free rate plus a fixed spread aligned with the spreads in ISDA's IBOR fallbacks."

In the U.S., for instance, Libor is supposed to be replaced by SOFR, the Secured Overnight Financing Rate, a risk-free rate based on the cost of borrowing secured by U.S. Treasuries. When Libor is replaced by "synthetic Libor," the synthetic Libor will be (1) SOFR, (2) compounded in arrears to get a term rate, (3) plus a spread. The spreads are based on the historical differences between Libor and the relevant risk-free rate; here they are.[1] So for instance when ICE stops polling banks for 3-month U.S. dollar Libor, 3-month dollar "synthetic Libor" will just be SOFR, compounded for three months, plus 0.26161%. 

I have written before that Libor is a "function call": You write in a contract that the interest rate will be Libor, and then you go and pull Libor in from ICE (or from a Bloomberg page that gets it from ICE), and you don't really care about the guts of how ICE calculates Libor. Right now ICE calculates Libor through this rickety mechanism of calling up banks and asking them to make up numbers. In the future it will calculate Libor by looking at published risk-free rates—which benchmark administrators calculate by looking at real transactions in secured funding markets—and adding a number to them. In theory Libor could just keep going forever, in this vestigial way: The "real" benchmark would be SOFR or whatever, and then Libor would just be a minor arithmetic manipulation of SOFR, SOFR plus 0.26%. You could still write loans or derivatives that reference Libor, and everyone would know that "Libor" is a weird archaism for "SOFR plus 0.26%."

But the regulators don't want that either: 

The BOE will hold executives to account for progress in the transition under the U.K.'s regulatory regime for senior managers, according to people familiar with the matter. If firms fail to take appropriate steps, there is the potential for measures such as capital sanctions, though these would come further down the line. 

Progress toward replacement benchmarks, such as the Secured Overnight Financing Rate in the U.S. and the Tokyo Overnight Average Rate in Japan, has been sluggish, and there are hopes Friday's announcement could accelerate the process -- particularly in the vast global derivatives market. …

The Fed, for its part, is intensifying its scrutiny of banks' efforts to shed their reliance on Libor, and has begun compiling more detailed evidence on their progress.

"In the months ahead, supervisors will focus on ensuring that firms are managing the remaining transition risks," said Randal Quarles, vice chair for supervision at the Federal Reserve Board and chair of the Financial Stability Board.

We've had several years now of regulators saying "you have to stop using Libor," and Libor is still pretty popular, but maybe this will do it. I wonder if old-school bankers will cling to Libor in a sort of hipsterish way. Maybe the senior banker will say "ah yeah their term loan is at Libor plus 50" and the analyst will be confused and go back to her desk and ask the associate "hey what does Libor plus 50 mean" and the associate will be like "it means SOFR plus 76, that's just how people talk sometimes."

A Banksy is canceled

I have mostly resisted writing about non-fungible tokens (NFTs), because they are not so much financial news as they are, uh, art news? The idea of an NFT is that you can buy sports memorabilia or art, but on the blockchain. Like there is a clip of LeBron James dunking a basketball, or a GIF of Nyan Cat, and they are more or less freely available on the internet, but you can buy a unique non-fungible copy of, or pointer to, the clip or the GIF proving that, in some sense, you own it. And that pointer is registered on a blockchain, and you can tell everyone "well, sure, anyone can look at Nyan Cat, but I own the real one."

Of course this is stupid but it's not so much stupider than anything else. I can look at the Mona Lisa on my computer too, even though the Louvre owns the real one. Well, no, I do think there are some real advantages to owning physical paintings. I'd rather have the original Mona Lisa in my living room than look at it on my computer. But the traditional markets for baseball cards and sports memorabilia are harder to distinguish from NFTs. The scuffed baseball that Barry Bonds hit into the stands for his 73rd home run in 2001 is not a particularly interesting physical object; you can buy a dozen nicer, newer, cleaner baseballs for $17.85 on Amazon. The home-run ball is a unique pointer to a memorable event, but it is not intuitively obvious that you should ascribe any value to that. A Mickey Mantle rookie card is a piece of cardboard with a picture and some stats printed on it, who cares. Why not print it on the blockchain.

So, sure, NFTs, whatever. Still this is kind of nuts:

Banksy isn't the only person publicly destroying Banksy artworks now. In the latest stunt in the craze for NFTs (Non Fungible Tokens), which have captured the imagination of many digital enthusiasts and a growing sector of the art world, a company called Injective Protocol purchased a Banksy work and converted it into an NFT—and then burned it on video.

Injective Protocol is a so-called DeFI ("decentralized finance") platform that builds Wall Street-style derivatives using blockchain-based smart contracts. It bought Banksy's Morons (White) (2006), depicting a crowded auction room with an ornately framed piece beside the auctioneer inscribed with the words "I can't believe you morons actually buy this shit." …

In a video posted on the BurntBanksy Twitter account and on YouTube, a representative of the company explains that, come on, they had to burn the physical piece because, if it still existed, the value would remain primarily there, rather than in the digital asset.

So you can buy a unique digital pointer to a physical work of art that does not exist. You can prove your exclusive ownership of the absence of a work of art. Great! The possibilities are dizzying. First, I have an incredibly amazing Ban—no, not a Banksy, I have an incredibly amazing lost masterpiece of Michelangelo here in my living room but unfortunately I lit it on fire. I tried to record a video of it burning but I pushed the wrong button on my phone, so there's no video. I did succeed, however, in converting this rare and now permanently lost masterpiece into an NFT on the blockchain, and I will now sell it to you. It was a picture of a cat, if that helps.

Second, I am going to sell a token that does not entitle you to ownership of the Mona Lisa. You can prove, on the blockchain, that you do not own the Mona Lisa, and that no one else does not own it in the unique way that you do not own it. I am going to record a video of me walking into the Louvre, and then walking out again half an hour later, and saying to the camera "yup the Mona Lisa is in there and I definitely do not have it." And then sell a token of … that whole thing. Why not. 

Third, I am going to download the YouTube video of them burning that Banksy, then I am going to delete the YouTube video, and then I am going to sell a token giving you ownership to the deleted video.

Fourth, I am going to sell tokens proving ownership, on the blockchain, of the same Banksy painting that they destroyed. Prove me wrong! You buy a token from Injective Protocol proving that you own that Banksy; your friend buys a token from me proving that she owns that Banksy. You say "no I own the real one." Your friend says "okay then go redeem your token for the painting." You're like "well they burnt the painting." I think you lose this argument! But what do I know about art.

Elsewhere Jack Dorsey is selling his first tweet as an NFT, sure. We're so close to a good idea here; what we need is for Dorsey to shut down Twitter and then sell an NFT of that.

Is cancel culture securities fraud?

Well, is it? Here is "Cancel Culture, Breach of Fiduciary Responsibility & Shareholder Lawsuits," by Robert McGee:

This paper discusses the cancel culture and focuses on the moral and legal implications of engaging in activities that reduce corporate profits. Top management that engages in the cancel culture might be opening themselves up to shareholder lawsuits for breach of fiduciary duty.

Fine, fiduciary-duty lawsuits rather than strictly securities fraud, but that's a small difference. Let's see the argument:

Cancel culture is a relatively recent phenomenon (if we exclude the McCarthy Era). It is an organized effort to silence or punish individuals or organizations that espouse views or engage in activities in which some group disapproves. Kohl's, Bed, Bath and Beyond, and several other large retail outlets stopped selling Mike Lindell's My Pillow because of his support for President Trump (Taylor & Meisenzahl, 2021)

Yes, yes, terrific, yes, say more:

Publicly held corporations have a fiduciary duty to their shareholders to engage in activities that increase profits, and not to engage in activities that decrease profits (Friedman, 1970). Refusing to do business with individuals or organizations that would increase their profits is a prima facie case of breach of fiduciary duty. Some small group of executives at the top decide to use their control over corporate assets to punish individuals or groups with which they disagree, at the expense of their shareholders. ... 

Some smart lawyers might see these breaches of fiduciary duties as an opportunity to launch class action lawsuits against these executives, and perhaps pierce the corporate veil, which would make them personally liable. Such lawsuits would remind the top management at these corporations that they have a fiduciary duty to their shareholders, which is a good thing. 

That's actually the last paragraph of the paper, which is three pages long. There is not, for instance, a detailed analysis of what claims could be brought and what defenses might be available. In fact, this argument does not strike me as particularly correct as a matter of law; the law of corporate fiduciary duties is subtler than that, and it certainly isn't "any time a company makes a decision that reduces its profits its shareholders can sue for breach of fiduciary duty." (The classic on the subject is Lynn Stout's "The Shareholder Value Myth.")

Still, I am a big proponent of the theory that "everything is securities fraud": Anything bad that a public company does can be recharacterized as securities fraud, because (1) bad things cause the stock to drop and (2) the company (arguably) didn't warn shareholders that it would do the bad thing. In January, I wrote about, uh, I guess "cancel culture"—Twitter banning Donald Trump—and I said:

Lots of companies do things that some people think are bad and that other people think are good—or, more accurately, they do things that some people think are bad and that other people think it would be bad to stop. There are securities-fraud-ish lawsuits against energy companies accusing them of worsening global warming by drilling for oil, but I bet there'd be a lot of securities-fraud-ish lawsuits against them if they stopped, too. ("Defendants told investors they were an oil company but then stopped drilling for oil and the stock went down," etc.) Banks face shareholder pressure to stop financing fossil fuels and guns, but they also face regulatory pressure to keep doing it. I feel like so far "everything is securities fraud" lawsuits tend to lean more to the progressive side, but there's nothing stopping a right-wing securities lawyer from trying to make a buck when companies do progressive things and their stocks go down.

It's starting! If everything is securities fraud, and "some stores refuse to sell an insurrectionist pillow" is a thing, then I guess that means it's securities fraud.

The Goldman Sachs partnership is canceled

These things are always a matter of degree, but here is a story about partners who have left Goldman Sachs Group Inc. recently, which argues that they're leaving because Goldman isn't a partnership anymore:

The exodus is partly a reflection of the approach taken by Mr. Solomon, a 59-year-old longtime investment banker who became chief executive late in 2018. He has sought to refashion Goldman, which went public more than two decades ago, into a more traditional public company, say current and former partners. That has produced a more top-down, hierarchical culture in which the institution is bigger than its people and Goldman's old-fashioned partnership structure — which imparts not only added pay and benefits but also a sense of family to the firm's top players — is less relevant, these people say.

Of course Goldman isn't a partnership, and hasn't been since its initial public offering in 1999, but under its previous chief executive officers it made efforts to retain a partnership culture, in which "partners" (technically called "participating managing directors") get treated a bit like partners of a private firm rather than managers of a public company:

Partners, who were named every two years, were feted at a black-tie dinner dance known internally as the "prom." Once part of the group, they often had spirited debates about promotions and firm strategy.

A basic problem for the chief executive officer of any company is that you can't keep track of everything that every division is doing, so how do you make sure that all the groups are doing good things? One answer is that you use financial incentives—you pay people more money if they bring in more revenue, you give good performers promotions, etc.—but this is not a great answer at an investment bank, since there are many ways for investment-bank employees to temporarily bring in a lot of revenue by doing terrible things. Basically the way to get ahead at an investment bank is to take horrible risks and have them work out for you; in the absence of effective supervision a lot of people will try that approach, and some of those horrible risks won't work out well.

Another answer is a system of hierarchical supervision: The CEO supervises a half-dozen people, each of whom supervises a half-dozen people, each of whom etc., so that every head of a business unit is supervised by someone who understands what they're up to. This is how normal companies normally work, and there is a lot to be said for it.

Another answer is a partnership culture: You have a bunch of employees, and you sort of audition them for partnership roles over a period of years. The ones who pass the audition—who work hard and prove themselves trustworthy, who buy into your partnership culture—get promoted to partner, and then you sort of trust them as "your partners." They are part of thec club, and you assume people in the club are properly acculturated to do the right thing. This is how most law firms work, and how 20th-century investment banking partnerships basically worked.

In the olden days, these partnerships were unlimited-liability partnerships; every partner's entire net worth was on the line with every other partner's trades. It focused the mind. When I was a junior associate at a law firm, I once had to go off to negotiate some document, and I asked the recently promoted partner supervising me if he had any advice. He thought for a minute and said: "Don't incur liability."[2] He thought a lot about that.

Obviously in a large global limited-liability partnership, or pretend partnership, this is harder. A Goldman partner in Malaysia incurred quite a bit of liability for the firm in the 1MDB scandal.[3] I have lost track of all the scandals that McKinsey's partnership has gotten up to. It is much easier to say that you have a culture of partnership than it is to have that culture actually influence everyone's behavior. 

Should electricity trades be canceled?

In a lot of financial markets there is a rule that "clearly erroneous" trades can be canceled after the fact. This is kind of a tough rule; often the error is clearer to one side than it is to the other. Still:

A firm hired to monitor Texas' power markets says the region's grid manager overpriced electricity over two days during last month's energy crisis, resulting in $16 billion in overcharges.

Amid the deep winter freeze that knocked nearly half of power generation offline, the Electric Reliability Council of Texas, known as Ercot, set the price of electricity at the $9,000-a-megawatt-hour maximum -- standard practice during a grid emergency. But Ercot left that price in place days longer than necessary, resulting in massive overcharges, according to Potomac Economics, an independent market monitor hired by the state of Texas to assess Ercot's performance. In an unusual move, the firm recommended in a letter to regulators that the pricing be corrected and that $16 billion in charges be reversed as a result. ...

While prices neared the $9,000 cap on the first day of the blackouts, they soon dipped to $1,200 -- a fluctuation that the utility commission later attributed to a computer glitch. The panel, which oversees the state's power system, ordered Ercot to manually set the price at the maximum to incentivize generators to feed more electricity into the grid during the period of supply scarcity. The market monitor argues that Ercot should have reset prices once rotating blackouts ended because, at the point, the emergency was over.

It's asking the commission to direct Ercot to correct the real-time price of electricity from 12 a.m. Feb. 18 to 9 a.m. Feb. 19. Doing so could save end-customers around $1.5 billion that otherwise would be passed through to them from electricity providers, Bevins said.

The weird thing here is that the maximum rate was not set by market transactions, even distressed or computer-glitchy market transactions; it was set by the regulators, and it seems to have been higher than necessary to call out maximum supply. The, like, Econ-101 objection here is that if you want to maximize long-term supply, you need to give suppliers absurd windfalls at times like this, because then people will go build extra power plants just for the possibility of charging $9,000 per megawatt-hour for three days once a decade. I dunno; that does not seem all that compelling.

Oh also Goldman Sachs is involved:

Goldman Sachs Group Inc. could gain more than $200 million from the physical sale of power and natural gas and from financial hedges after spot prices surged across much of the U.S., according to people with knowledge of the matter. Morgan Stanley's gains could come in under $200 million, according to a person with familiar with the matter, and Bank of America Corp. stands to rake in profits as well.

But those gains in their totality may prove elusive given the crisis's fallout -- tipping energy companies into bankruptcy, triggering legal challenges and prompting government intervention. The uncertainty is such that Goldman executives estimate that the bank may realize less than half of its paper gains, the people said, asking not to be identified as the information isn't public.

It's possible that saying "oops the price was wrong, it was actually a lot cheaper than that" is a better way to distribute the losses here—basically by taking away some giant windfalls from sellers—than is letting a bunch of buyers go bankrupt. Bankruptcies would take away a lot of those windfalls anyway, but in a more complicated and expensive way.

Wrong Curve

Ahh, sure:

Excitable speculators mistakenly rushed to invest in the native token of decentralized finance protocol Curve Finance (CRV) after reports emerged that payments giant PayPal has acquired the unrelated Israel-based crypto custody firm, Curv.

News of PayPal's Curv acquisition was reported on March 2, with the publications citing anonymous sources "familiar with the matter." Israel-based media has reported the company may have been sold for between $200 million and $300 million.

Within an hour of the news breaking, Curve's CRV token had rallied by more than 10% as opportunistic traders raced each other to enter the markets — pushing prices up from roughly $2.30 to $2.60.

I keep lazily saying that crypto is about rediscovering the lessons of regular financial history, but faster. Now crypto is up to the part of financial history where people keep buying stocks with the wrong tickers.

Wrong Ark

I have argued in the past that, if you run a smallish public company, you might as well take advantage of the wrong-ticker thing by giving your company a name that is confusingly similar to a more interesting company. Or a more interesting concept, really; you don't even have to get confused with a company. People will buy a stock if its ticker sounds like a popular product or person or theme or whatever; they are not picky. "Echelon Corp. was acquired in 2018," I wrote last month, "leaving the ELON ticker free, and I honestly can't believe it's lasted so long, that is just absolutely free money lying on the ground, I am going to start the Excellent Levine Operating Newco SPAC this afternoon and watch the money roll in." 

I was making a joke about a special purpose acquisition company called Ark Global Acquisition Corp., which rallied in its first few days of trading possibly because people confused it with ARK Investment Management LLC, Cathie Wood's white-hot exchange-traded-fund firm. That was then! Now ARK (the ETF firm) is having a rough time, and Ark (the SPAC) is pivoting (via Joe Weisenthal):

Ark Global Acquisition Corp. [Friday] announced that it has changed its name to Alkuri Global Acquisition Corp. and its ticker symbol from 'ARKIU' to 'KURIU' following customary regulatory approvals. ...

"Whereas Ark was a name of convenience built on the initials of our sponsors, Alkuri means 'to run toward,' which reflects our belief that high-growth startups and technology companies need faster, more flexible and efficient paths to fundraising and to the public capital markets," said Rich Williams, CEO of Alkuri Global Acquisition Corp. 

Let's be clear that it means "to run toward"  in Esperanto. "Forkuri" is apparently Esperanto for "to run away," which is plausibly what is actually going on here. 

How's GameStop doing?

Man, GameStop Corp. common stock closed on Friday at $137.74, up 35% on the week. At 11:14 a.m. today it hit $196.69.When I first wrote about GameStop on Jan. 25, it was because the stock had gotten all the way up to $65.01, which seemed nuts. Here's a … confused ... viral Twitter thread claiming that it's going to be a $7 trillion company. We're gonna do this all over again aren't we?

My baseline assumption was always that GameStop would go up and then come down, as generally happens with bubbles, but I was jokingly open to the possibility that instead GameStop would become a permanent store of value for purely social and self-referential reasons. I suppose the third possibility is that GameStop will go through a series of monthly boom and bust cycles, that it will sometimes trade at $20 and sometimes at $400, in rapid alternation, forever. If the source of GameStop's value is that it's fun, it needs to keep being fun to keep being valuable.

Things happen

Tesla Is Plugging a Secret Mega-Battery Into the Texas Grid. GE Nears Deal to Combine Aircraft-Leasing Unit With AerCap. In a Surprise Twist, Most Activist Shorts Are Up This Year. Citi Sees the Days of Traders Slamming Phones Coming to an End. John McAfee got indicted some more. Oxford-AstraZeneca Covid-19 Vaccine Startup in Conflict With University Ahead of Planned IPO. Hong Kong's Jardine to restructure after decades of pressure. Federal Corporate Law and the Business of Banking. When SPAC-Man Chamath Palihapitiya Speaks, Reddit and Wall Street Listen. GME, Doge, Supreme: How Getting Rich Went Full Internet. Excel Never Dies. "Maybe they buy a new Tesla or convertible, but they don't go out and start buying airplanes overnight." 

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[1] ISDA says: "Following multiple industry consultations by ISDA, it was determined that the fallback for each IBOR setting will be based on the relevant RFR compounded in arrears to address differences in tenor, plus a spread adjustment to account for the credit risk premium and other factors, calculated using a historical median approach over a five-year lookback period from the date of an announcement on cessation or non-representativeness."

[2] I worked at one of the last remaining unlimited-liability partnerships in the biglaw business. Oh, disclosure, I also worked at Goldman, though long after its private-partnership days. I did far more to incur liability there, of course, but it was fine.

[3] "What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences," by Steven Mandis, is a good account of Goldman's cultural change in recent decades, particularly focused on dilution of the partnership culture.
 

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