Tuesday, April 9, 2013

CFTC Investigating Potential Manipulation in Interest Rate Swap Market

By Tim Dulaney, PhD and Tim Husson, PhD

Bloomberg's Matthew Leising is reporting that the Commodity Futures Trading Commission has issued subpoenas to current and former employees at swap brokerage firm ICAP (IAP) "and as many as 15 Wall Street banks" for alleged manipulation of a key benchmark price in the interest rate swap market.

The benchmark, known as ISDAfix, "provides average mid-market swap rates for six major currencies at selected maturities on a daily basis."  Similar to LIBOR, the rates are set based on end-of-day polling of major banks (not on actual transactions) and is calculated and published by Thompson Reuters.  The CFTC's investigation is focusing on whether "ICAP brokers colluded with dealers who stand to profit from inaccurate quotes, including failing to update published prices after trades occur."  The article also notes the similarity between this investigation and the recent LIBOR bid-rigging scandal that also involved collusion between the bank employees who set the rate and derivative traders who could profit from a known change in that rate.  According to the Financial Times, "ICAP has placed several people on leave in connection with [the LIBOR] probe," as well.

According to the article, ICAP is the largest broker of interest rate swaps, trading an average of $1.4 trillion in notional transactions daily.  The article notes that ICAP has been "nicknamed 'Treasure Island' because of the size of the commissions it earns."  The interest rate swap market is one of the largest financial markets in existence and is a way for institutions to match the cashflows between their income and liabilities, amongst other purposes.  While traditional interest rate swap deals are conducted over-the-counter, rather than on a public exchange, there has been a move recently towards replacing interest rate swaps with economically equivalent deliverable interest rate swap futures, which could trade on a public exchange and thus increase transparency.

Certainly any manipulation of a key benchmark rate is big news and could affect literally trillions of dollars in notional value of derivatives. We will continue to follow this story as it develops, both here and through our Twitter feeds.

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