If municipal bond market observers feel there are other time bombs out there waiting to detonate that resemble the accusations surrounding the manipulation of Libor, they won’t be found in variable-rate debt tied to the SIFMA municipal swap index.
The Securities Industry and Financial Markets Association index is much more of a market-driven rate, industry pros say, as opposed to what the bank-driven rate the London Interbank Offered Rate represents. Thus, the degree to which the process for setting the rate for the SIFMA index differs from that of Libor inoculates it from a similar potential for manipulation.
Those differences in the methodologies used to set the two rates — to which hedged, variable-rate exposures are pegged — are key, according to Tim McKeon, a managing director who heads the government banking debt finance group at U.S. Bank.
“I don’t see SIFMA fitting into the same paradigm,” he said. “It’s really a market-driven rate. You’ve got the investors participating with the remarketing agents and the underwriting banks, in terms of where and how they would value the paper, at what cost and what interest rate.”
Actual rates paid to investors by issuers are used to calculate the SIFMA municipal swap index, the trade group said. SIFMA is derived from data points for variable-rate demand obligations that reset on Tuesdays, and are effective Wednesdays.
The SIFMA rate uses criteria to filter through a universe of around 12,000 CUSIP numbers of muni VRDO resets, at a par amount of around $300 billion. Of that, around 500 to 700, valued at almost $33 billion, calculate the index weekly, said Leslie Norwood, managing director and co-head of SIFMA’s municipal securities division.
The criteria reflect the high-grade, short-term VRDO market in municipal securities. Securities must have a short-term rating in the highest grade: VMIG-1 by Moody’s Investors Service or A-1-plus by Standard & Poor’s. It cannot be subject to the alternative minimum tax; it must be a weekly reset, effective on Wednesday; must have an outstanding amount of $10 million or more, and pay interest on a monthly basis that is calculated on an actual basis.
Finally, the index will include only one quote per issuer per remarketing agent. Issues from all states are eligible.
Using that criteria, Thomson Reuters, SIFMA’s calculation agent, runs all the rates, drops those that do not apply, and determines the index every Wednesday. It disseminates the results to subscribers on Thursday.
By comparison, the British Bankers’ Association and its member banks set Libor daily for 10 currencies. The six to 18 contributing banks are required to be regulated and authorized to trade on the London money market.
The BBA establishes Libor based on the rates that designated banks would have to pay for an unsecured loan for each designated maturity period for each currency.
Each day before noon, the banks respond to the BBA’s question: “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 a.m.?”
The banks notify the BBA of their costs of borrowing funds at different maturity dates.
Rates that are contributed are then ranked in descending order, using the arithmetic mean of only the middle two quartiles to formulate the BBA Libor calculation for that particular currency and maturity.
Thomson Reuters then publishes Libor, including the banks’ quotes that represent the foundation for Libor’s calculation.
Critics of Libor argue that the rate represents what banks would pay for funds rather than what they are actually paying, leading to control problems and possible mispricing. The BBA and its designated banks set Libor without regulatory oversight.
Federated Investors is one of the largest institutions in the country in the variable-rate demand note market. The firm has $22 billion in tax-exempt money markets, said Mary Jo Ochson, head of the firm’s tax-free money-market group. At any given time, about 70% of those funds are VRDNs.
Federated is quite secure with the VRDN market, as well as the SIFMA index’s role within it, Ochson said.
“SIFMA is based off of actual tax-exempt issues in the marketplace,” she said. “I think it would be very hard [to manipulate the rate]; there are so many VRDNs out there. Just the way it’s calculated would preclude that. It truly is the market rate.”
The story for muni investors began during the auction-rate securities crisis. Back in 2008, ARS were hedged with swaps pegged to a percentage of Libor, which is designed to be a gauge of how much banks charge each other for short-term loans.
Barclays Bank and others are alleged to have conspired to keep Libor artificially low in order to appear as though the unfolding financial crisis was having no impact on their borrowing costs. That, in turn, had the effect of reducing payments to issuers with Libor-related swaps.
Barclays entered into a settlement with U.S. and U.K. regulators on June 27 and agreed to pay more than $450 million to settle allegations that it manipulated Libor.
On April 30, plaintiffs, among them the city of Baltimore, filed an amended complaint against more than 15 financial institutions, including Bank of America Corp., Barclays, JPMorgan Chase & Co., Citigroup Inc. and others. The plaintiffs alleged in the complaint that the financial institutions, from a date on or before Aug. 9, 2007, through at least February 2009, suppressed Libor in order to pay lower interest rates on Libor-based financial instruments that they had sold to investors, including the Baltimore plaintiffs.
In late June, attorneys for the defendant banks responded by filing to dismiss the litigation.