BBA LIBOR—AN INTRODUCTION

  BBA LIBOR stands for London InterBank Offered Rate. It is produced for 10 currencies with 15 maturities quoted for each, ranging from overnight to 12 months producing 150 rates each business day. BBA LIBOR is a benchmark; giving an indication of the average rate a leading bank, for a given currency, can obtain unsecured funding for a given period in a given currency. It therefore represents the lowest real-world cost of unsecured funding in the London market.

  Individual BBA LIBOR rates are the end product of a calculation based upon submissions from a panel, made up of the largest, most active banks in each currency BBA LIBOR is quoted for.

  The key concept is that BBA LIBOR is based upon the offered rate, and not the bid rate. Every contributor bank is asked to base their LIBOR submissions on the following 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 11.00 am?" Therefore submissions are based upon the lowest perceived rate that a bank on a certain currency panel could go into the inter-bank money market and obtain sizable funding, for a given maturity.

  The rates are not based on actual transaction, indeed it would not be possible to create the suite of LIBOR rates if this was a requirement, as not all banks will require funds in marketable size each day in each of the currencies and maturities they quote. However, this does not mean the rates are inaccurate. A bank will know what its credit and liquidity risk profile is from rates at which it has dealt, and can construct a curve to predict accurately the correct rate for currencies or maturities in which it has not been active.

  "Reasonable market size" is intentionally left undefined. This is because it would have to be constantly monitored, and in the current conditions it would have to be changed almost daily, certainly every week, and would vary between currencies, maturities and even contributors. This would lead to a great deal of confusion.

  The current definition became the standard after a review in 1998 where previous submissions from panel members were based upon the following: "At what rate do you think interbank term deposits will be offered by one prime bank to another prime bank for a in a reasonable market size today at 11.00 am?" The new definition enables accountability for the rates.

WHAT IS BBA LIBOR USED FOR?

  BBA LIBOR is the primary benchmark for short term interest rates globally. It is used as a barometer to measure strain in money markets and often as a gauge of the market's expectation of future central bank interest rates. Independent research indicates that around $350 trillion of swaps and $10 trillion of loans are indexed to BBA LIBOR. It is the basis for settlement of interest rate contracts on many of the world's major futures and options exchanges. It is written into standard derivative and loan documentation such as the ISDA terms. It is also used for an increasing range of retail products, such as mortgages and college loans.

SELECTION OF CONTRIBUTORS

  Contributor banks are selected for currency panels with the aim of reflecting the balance of the market for a given currency based upon three guiding principles:

(1)  scale of market activity;

(2)  credit rating; and

(3)  perceived expertise in the currency concerned.

  Each Panel for the 10 currencies, ranging from 8 to 16 contributors, is chosen by the independent Foreign Exchange and Money Markets Committee (FX & MM Committee) to give the best representation of activity within the London money market for a particular currency. A full list is included as Appendix I. Therefore, with all due to consideration to current economic situations, the LIBOR submissions from panel members will be on average the lowest interbank unsecured loan offers within the money market that are on offer.

  Every year the FX & MM Committee undertakes an assessment of each panel, based upon a review by the BBA of the contributors. The review re-evaluates each bank by ranking them according to their total money market and swaps activity over the previous year. The review is not limited to contributors as any Banks can submit themselves to the evaluation process for any currency.

CALCULATION

  Reuters are our designated calculation agent. They audit data submitted by panel banks and create the rates using the definitions provided by the FX & MM Committee, and they do so under the supervision of BBA.

  Each cash desk in a contributor bank has a Reuters application installed. Each morning between 11.00 and 11.20 an individual at each bank, typically the currency dealer, takes their own rates for the day and inputs them into this, which links directly to the fixings team at Reuters. Banks cannot see each others' rates as they submit, only after final publication. Reuters run a barrage of automated and manual tests on the submitted rates before they are sent to the calculation engine. After calculation the data is released to the market, via Reuters and nine other data vendors.

  Every BBA LIBOR rate produced by Reuters is calculated by the same method, using a trimmed arithmetic mean. Once Reuters receive each contributor submissions they rank them in descending order and then drop the top and bottom quartiles—this is the trimming. The middle two quartiles reflecting 50% of the quotes are then averaged to create a BBA LIBOR quote. This is repeated for every currency and maturity resulting in 150 rates produced every business day.

  Please see the below example for a US dollar quote for one maturity.

WEST LB	2.85000
ROYAL BANK OF SCOTLAND	2.75000
H B O S	2.70000
BARCLAYS	2.70000
BANK OF AMERICA	2.70000 }
J P MORGAN	2.68000
ROYAL BANK OF CANADA	2.67000
UBS	2.65000	LIBOR RATE
RABOBANK	2.65000	2,66250
NORINCHUKIN	2.65000
LLOYDS	2.65000
H S B C	2.65000
CREDIT SUISSE FIRST BOSTON	2.65000
CITIGROUP	2.65000
BANK OF TOKYO MITSUBISHI UFJ	2.65000
DEUTSCHE BANK	2.63000

  The decision to drop the bottom and top quartiles in the calculation was taking to increase the accuracy of BBA LIBOR quotes. As previously described, BBA LIBOR is a benchmark and including outliers for any given reason will not reflect a market rate. By dropping outliers it is out of the control of any individual panel contributor to influence the calculation and affect the BBA LIBOR quote. For a complete list of all Historic BBA LIBOR data please refer to BBA Website (http://www.bba.org.uk/bba/jsp/polopoly.jsp?d=141&a=627)

INCEPTION OF BBA LIBOR

  BBA LIBOR was first developed in the 1980s as demand grew for an accurate measure of the real rate at which banks would lend money to each other. This became increasingly important as London's status grew as an international financial centre. More than 20% of all international bank lending and more than 30% of all foreign exchange transactions now take place in London.

  In 1984 UK banks asked the BBA to develop a calculation that could be used as an impartial basis for calculating interest on syndicated loans. This led to the creation of "BBAIRS"—the BBA Interest Rate Settlement in 1985, which in 1986 became BBA LIBOR. The objectivity and accuracy of the rates allowed derivatives to be created based on the data as a reference, and this has flourished to become an enormously successful cornerstone of business transacted in the City and worldwide.