Central Banks Aim to Improve Reference Rate Practices

A report entitled
‘Towards better reference rate practices: a central bank perspective’
has been released by a working group established by the Economic Consultative Committee (ECC). Chaired by Hiroshi Nakaso, assistant governor, Bank of Japan (BoJ), the group comprised officials from 13 central banks and monetary authorities.

The report reviews issues relating to the use and production of reference rates, such as interest rates, from the perspective of central banks. These reflect the possible risks for monetary policy transmission and financial stability that may arise from deficiencies in the design of reference rates, market abuse, or from market participants using reference rates which embody economic exposures other than the ones they actually want or need.

In parallel to initiatives in other forums and jurisdictions, including work by the International Organisation of Securities Commissions (IOSCO), the European Banking Authority (EBA)/European Securities and Markets Authority (ESMA) and the UK Wheatley Review, the report provides recommendations on how to improve reference rate practices from a central bank perspective.

The working group identifies an urgent need to strengthen the reliability and robustness of existing reference rates and a strong case for enhancing reference rate choice. Both call for prompt action by the private and the public sector.

The Bank of England’s (BoE) outgoing governor Sir Mervyn King, who is also chairman of the ECC and the Global Economy Meeting (GEM), said: “The report makes a significant contribution to the ongoing examination of reference rates used in financial markets. It is clear that central banks must play an important role in supporting the development of alternative reference rates.”

The working group was set up last September to examine reference rates used in financial markets and to consult with the market in order to provide input into the broader official debate coordinated by the Financial Stability Board (FSB).

The ECC is an informal group that supports the GEM. The ECC includes all Bank for International Settlements (BIS) board member governors, the central bank governors from India and Brazil, and the BIS general manager. The ECC assembles proposals for consideration by the GEM. In addition, the ECC chairman initiates recommendations to the GEM on the appointment of chairs of the main central bank committees and on the composition and organisation of those committees.

In order to enhance reference rate choice, central banks can promote the development and improvement of (near) credit risk free reference rates, primarily covering the key interest rates but also overnight rates and overnight index swap (OIS) rates or general collateral (GC) repo rates, which are also key economic indicators. Public authorities could also help bring together market participants or industry groups to coalesce around any changes and help smooth any transition. Central banks could, in some cases, even play a more active role by, for example, becoming directly involved in reference rate design and production, although robustness will ultimately depend on a sound rate setting process based on a liquid market. The failures of the industry-led Libor rate setting mechanism are most likely to be foremost in central bankers’ minds as they explore alternative reference rate designs and practices.

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