Speaker 1: Hello, and welcome to another episode of the Odd Thoughts podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe. Wasn't all so Joe.
Speaker 1: This is the third episode of our Live Bard series.
Speaker 1: You know, I said it in the beginning, and it
Speaker 1: was a big, facetious This is one of those things
Speaker 1: that I felt was extremely important to understand that I
Speaker 1: didn't have much knowledge on, and so I'm very happy
Speaker 1: that we finally working through all that. You know, our
Speaker 1: first episode we sort of talked about the problems with
Speaker 1: librar pre financial crisis and post financial crisis, and then
Speaker 1: in the second episode we talked a lot about the
Speaker 1: transition away from library and how that's going. In this episode,
Speaker 1: we are going to talk to someone who's actually actively
Speaker 1: trying to come up with an alternative reference rate. Yeah.
Speaker 1: It's interesting because I know that there is a very
Speaker 1: big push a foot to move you know, as we've
Speaker 1: talked about from libor over to so FUR, and they're
Speaker 1: all kinds of efforts going on for that front. But
Speaker 1: I guess that is not the only theoretical alternative approach. Yeah, exactly. So,
Speaker 1: even though there's this regulatory push towards the security overnight
Speaker 1: financing rate or so fur there are well, there is
Speaker 1: the potential for alternative rates to enter the market, and
Speaker 1: we have the perfect person to talk about this. We're
Speaker 1: gonna be speaking with Richard Sandor. He's the chairman and
Speaker 1: CEO of the American Financial Exchange, also someone who occasionally
Speaker 1: is referred to as the father of financial futures, has
Speaker 1: a lot of experience in the derivatives market and has
Speaker 1: well invented quite a few contracts over the years. So again,
Speaker 1: the perfect person. I'm really looking forward to this. Okay,
Speaker 1: let's bring him on. Richard, thank you so much for
Speaker 1: coming on offts. Oh, it's my pleasure. Thank you for
Speaker 1: the invitation, and I'm happy to be here with both
Speaker 1: of you. Thank you, thank you. So I gave a
Speaker 1: little bit of an intro just then. Um, but it's
Speaker 1: kind of hard to summarize your career because it's quite
Speaker 1: expensive and you've done quite a few things. Can can
Speaker 1: you try to summarize it in a in a nutshell
Speaker 1: for our viewers, viewers, for our listeners. I should say,
Speaker 1: it's really hard to talk about yourself. I leave that
Speaker 1: to others generally, But let's say I'm a serial and
Speaker 1: the inventor and the financial innovator. I get it wrong
Speaker 1: a bunch of times and then get it right too.
Speaker 1: So I've spent forty five years trying to observe capital
Speaker 1: markets and see what instruments can be developed to minimize
Speaker 1: transaction costs and achieve social objectives. And Library and its
Speaker 1: successors fit into that. And like most inventive activity, there's
Speaker 1: a spark. And we had sold our last exchange, which
Speaker 1: was a series of market based solutions to global warming,
Speaker 1: two ice in twenty ten. UM. It was very successful.
Speaker 1: Our investors made seven and a half to fifteen times
Speaker 1: their money between oh three and ten. A sale price
Speaker 1: was six hundred million. And we had developed exchanges in
Speaker 1: North America, the UK and China, and we reformed the incubator,
Speaker 1: which is something called the FP because we were looking
Speaker 1: for new markets and we started to look at water. UM.
Speaker 1: We had a contract with the state of New Mexico,
Speaker 1: California looking at China because we thought that water would
Speaker 1: be and still do think the commodity of the twenty
Speaker 1: first century. I picked up a newspaper in twenty eleven
Speaker 1: UH and read that the Royal Bank of Scotland fired
Speaker 1: four people for manipulating library. Uh called the team in
Speaker 1: and even I know it takes two to manipulate. So
Speaker 1: if there was one, then there was going to be
Speaker 1: a second, and we by no really expanded too. Would
Speaker 1: go to four, four, would go to eight, etcetera. And
Speaker 1: that ultimately we thought that there would be a demise
Speaker 1: in library, it would end, and that we would set
Speaker 1: off on a ten year odyssey to develop a replacement
Speaker 1: to librar. Library was unusual and in that it was
Speaker 1: the only asset class that I knew about that had
Speaker 1: a single benchmark, all because of alone in the sixties
Speaker 1: to the shah Iran. If you take a look at
Speaker 1: crude oil, it's got w t I, it's got brand,
Speaker 1: it's got Dubai, it's now gonna Shanghai. If we look
Speaker 1: at the equity markets, they have Nastack SMP, Dow Russell
Speaker 1: Value Line, more stock indexes than there are stocks, and
Speaker 1: the same with fixed income. So what is this anomaly
Speaker 1: called library? And how could we have hundreds of trillions
Speaker 1: dollars tied to a pole that would be like electing
Speaker 1: the president of the United States based on the Wall
Speaker 1: Street Journal poll. It made no sense whatsoever that it
Speaker 1: was the only benchmark, and it wasn't even market determined.
Speaker 1: So we set out and said, let's develop something that
Speaker 1: is everything that Libor isn't. Let's make it transparent, let's
Speaker 1: make it regulated, let's make it based on transactions only,
Speaker 1: and let's make it American. London has lib Or, Europe
Speaker 1: as Europe, or even Hong Kong as UH high bor.
Speaker 1: How could it be that the world's largest economy didn't
Speaker 1: have its own benchmark. So UM I got on a
Speaker 1: plane and instead of going to London, Parish, Shanghai, Hong Kong,
Speaker 1: uh and Vienna, etcetera, I ended up in Bentonville, Arkansas, Tupelo, Mississippi,
Speaker 1: San Antonio, Texas, Green Bay, Wisconsin and visited a hundred
Speaker 1: and twenty five small banks with my colleague. So if
Speaker 1: it was going to be a benchmark, it would be
Speaker 1: one that was based on American banks overnight, unsecured lending
Speaker 1: to each other. We were naturally viewed with some skepticism.
Speaker 1: Interest rates for zero. People said library is never gonna
Speaker 1: go away. You don't understand, Dr Sandor, this is the
Speaker 1: bedrock of all finance, and your climbing up a mountain
Speaker 1: and you need to go back to Chicago, because not,
Speaker 1: that's not the way it works. We felt quite opposite,
Speaker 1: and actually as a contrariant and as an inventor, that
Speaker 1: was really bullish because everybody thought that there was no
Speaker 1: need for it. And oftentimes in my experience, whether it's
Speaker 1: financial futures, the derivatives, everybody said no need for it.
Speaker 1: Whether it was acid rain and the mark and no
Speaker 1: need for it, catastrophe bonds, no need for it, climate
Speaker 1: change no not happening, no need for it. So whatever
Speaker 1: small success I've had, it's been where the lights and
Speaker 1: beacon of the industry has told me that there's no
Speaker 1: need for it. So talk to us about your approach.
Speaker 1: You mentioned the sort of absurdity that the world operated
Speaker 1: on a single benchmark, even though most things, whether it's
Speaker 1: doctor or multiple benchmarks all around the world. What is
Speaker 1: it about the way that UM your index would be
Speaker 1: constructed that's a better for use. Why regionalization is good
Speaker 1: but also less prone to some of the manipulation issues
Speaker 1: that of course accelerated or caused live worth of mine
Speaker 1: great questions. So we again we thought that we would
Speaker 1: stay away from siffy UM the systemically important financial institutions,
Speaker 1: and we would go to recruit the five thousand by
Speaker 1: inks Um that were non citfies and not go after
Speaker 1: the fifteen Ciffy. So our market was going to be
Speaker 1: five thousand banks that have approximately nine tribuon and assets
Speaker 1: about half of that and floating rate, and that would
Speaker 1: be Regional's mid sized community banks. And if we had
Speaker 1: breath as well as depth that the competitive markets like
Speaker 1: wheat and soybeans and gold, et cetera, that were regulated
Speaker 1: and we're transaction based, manipulation could not occur. And if
Speaker 1: it occur, if it was regulated, we had policing and
Speaker 1: enforcement powers. So we hooked up with sea Boat. We said,
Speaker 1: here's our algorithm, here's our benchmarks. You have a big
Speaker 1: compliance department, you're an s R. Oh want to securities exchange,
Speaker 1: you own a commodities exchange. Why don't you be our
Speaker 1: compliance folks and take a look at every single transaction,
Speaker 1: have the complete tape, have a complete compliance thing, and
Speaker 1: we will make sure that that we are not manipulable
Speaker 1: and we will have to anti spoofing rules. Concentrations will
Speaker 1: be limited, we will be able to speak to anybody.
Speaker 1: We have a business conduct committee, we have a hundred
Speaker 1: and twenty five page rule book of students, and don't
Speaker 1: we have the ability to bring up a bank that
Speaker 1: misbehaves and before a business conduct committee. We know how
Speaker 1: to do this. So we set in place all of
Speaker 1: the things that traditionally regulated and transportent markets perform. So
Speaker 1: we started with four banks, we traded thirteen million a day.
Speaker 1: We're up to a hundred and forty three banks, another
Speaker 1: twelve hundred correspondents, so we have about thirty percent of
Speaker 1: America's banks. We trade two and a half billion dollars
Speaker 1: a day after four years, and we have eighty participants
Speaker 1: in any given quarter a month, so we are deep
Speaker 1: and we are broad. We also brought in iasco because
Speaker 1: we thought it was important that we get independently audited
Speaker 1: with regard to liquidity, concentration, etcetera. So an independent audit
Speaker 1: was accurred by a major accounting firm that said we
Speaker 1: were AYASCO compliant. When we hit a billion dollars a day,
Speaker 1: we went and got to see FDC approval. They have
Speaker 1: to make sure the index is viable before they allow
Speaker 1: you to trade a future. And we have broadened the
Speaker 1: market from not only hundred forty three banks, they include
Speaker 1: all of the big regionals Regions, Northern Trust, the fifth Third,
Speaker 1: et cetera, fifty percent of the banks just under between
Speaker 1: five and sixty billion, and the twelve hundred community banks.
Speaker 1: We also have Jefferies, the Progra dealers, insurance companies like
Speaker 1: Northwestern Money Managers, Goggenheim just joined, and now we have
Speaker 1: companies like John Deere. We feel that a transparent, regulated
Speaker 1: market that has eighty participants, that does billions a day
Speaker 1: is an adequate benchmark, and how you can see the tape.
Speaker 1: Every trade is transparent, it can be monitored, it can
Speaker 1: be audited, and so we feel we've just taken an
Speaker 1: age old tradition that exists in Chicago, provide many buyers
Speaker 1: and sellers of a broad commodity financial instrument, and the
Speaker 1: rest will take care of itself. Richard, I want him
Speaker 1: to go back to UM. I guess this's the notion
Speaker 1: that you had that you you didn't have to have
Speaker 1: a reference rate, a sort of one size fits all
Speaker 1: reference rate. You could have shades of it. I have
Speaker 1: maybe a stupid question, but some people would perhaps argue
Speaker 1: that one of the good things about having a benchmark,
Speaker 1: a single benchmark, is the simplicity how would you respond
Speaker 1: to that idea? That's great. Simplicity is fine. If you're
Speaker 1: willing to roll the entire world economy on simpleness, then
Speaker 1: you get what you would get a total breakdown. You
Speaker 1: get simplicity, you just get a financial crisis. Why would
Speaker 1: you want Look, well, I'm a professional economist. I teach
Speaker 1: at the University of Chicago. I've been doing it for
Speaker 1: forty five years. The economists don't know anything. Okay, we
Speaker 1: can't forecast, we haven't foreseen two major crisis is meltdowns
Speaker 1: things of this thing, there's only one thing you could
Speaker 1: probably get every economist. So if you go to China,
Speaker 1: you go to London, Roxford, you go to the University
Speaker 1: of Chicago, one and only one thing will everybody agree on,
Speaker 1: and that is diversification. Right, that's you probably will get.
Speaker 1: Nobody will argue against diversification. R Right. It's the one
Speaker 1: thing we know. I don't know whether the market is
Speaker 1: going to go up or down, whether it's gonna crash,
Speaker 1: fall apart. We don't know anything in finance. And he
Speaker 1: can which other than choice and diversification is good. So obviously, um,
Speaker 1: you know, as you say, diversification of things are good.
Speaker 1: The dependent on a single librlar proved to be problematic.
Speaker 1: As we set up in the intro, regulators are pushing
Speaker 1: for this Libel replacement SOFA which we've discussed based on
Speaker 1: overnight secured financing. Your you take a different approach. Can
Speaker 1: your vision, your index thrive in a world in which
Speaker 1: regulators are pushing for everything out or pushing for another
Speaker 1: sort of universal Libel replacement? And can we have this
Speaker 1: sort of diversification even if regulators sort of have the
Speaker 1: specification we I don't think regulators are as singular in
Speaker 1: their attitudes and thought processes as the popular press with indicate.
Speaker 1: For the financial press, we have spoken to them and uh,
Speaker 1: that is that we've brief because this is how we operate.
Speaker 1: We for the last five years, we go down in Washington,
Speaker 1: we brief the FED, the O C C B F
Speaker 1: D I C B SEC, that's the FDC. And when
Speaker 1: I say to them what I am sharing with you,
Speaker 1: that there should be a free market for ideas and
Speaker 1: competition for ideas, not one, not a singular one, said
Speaker 1: that's a bad idea. Okay, they have not said they
Speaker 1: are officially neutral. Um, we already have our premise from
Speaker 1: twenty eleven being validated. We got so Fur, we got Sonia,
Speaker 1: and we got Tona. We did Esther. We're already breaking
Speaker 1: down the idea. It a simple idea. Now, why would
Speaker 1: you have only a risk re rate. You need a
Speaker 1: risk rate because in fact, what we've learned in the
Speaker 1: last two crisises, there's a flight to quality and interest
Speaker 1: rates between government guaranteed paper and private uh borrowing non
Speaker 1: public diverge on crisis is and secularly when there's a recession.
Speaker 1: So you need a credit component in an index. We
Speaker 1: are the only index that has a credit component. Five
Speaker 1: thousand American banks want to develop assets which reflect their
Speaker 1: borrowing costs so they can match the two in an
Speaker 1: asset liability management process. So if you want to make
Speaker 1: the banking system stable, you should develop floating rate assets
Speaker 1: that reflect the floating rate costs. And for five thousand
Speaker 1: American banks, the risk free rate is fabulous. We believe
Speaker 1: in So for we think it's a great thing, it's terrific.
Speaker 1: For the money center banks it doesn't fit and the
Speaker 1: five thousand small banks. Getting back to my opening comment
Speaker 1: about social purpose, we had Jeremy Stein with who is
Speaker 1: the chair of the Harvard Economics Department. We funded a
Speaker 1: lecture at Northwestern two years ago, and it's unambiguous that
Speaker 1: that these midsize, regional, and small banks disproportionately create jobs
Speaker 1: in America. This is a critical time in our economy
Speaker 1: in the world. Why would one be against the institutions
Speaker 1: that function and provide financing to America's businesses, small businesses
Speaker 1: which disproportionally create jobs. I don't get that opposition. It's
Speaker 1: like being in a Madrid painting. It's surreal. Richard, you're
Speaker 1: talking about the importance of having a credit component in
Speaker 1: uh this benchmark reference rate. I wanted to ask you,
Speaker 1: I think the loans that you're looking at include not
Speaker 1: just loans between banks, but also between broker dealers and
Speaker 1: private equity as well. UM. I think that's right. Could
Speaker 1: you maybe talk a little bit about why you thought
Speaker 1: it was important to include those entities as well. Yeah,
Speaker 1: I I think the job is not only to create
Speaker 1: liquidity in the banking system, but it is the bridge
Speaker 1: the market between the banking system and the capital market.
Speaker 1: And if you have Serberis or Jefferies or John Deere
Speaker 1: or Northwestern Mutual that also resources of liquidity, then you
Speaker 1: bring to bear the power of more and more players
Speaker 1: and greater breath to the market. So that's why we
Speaker 1: and all of those folks either have floating rate assets,
Speaker 1: they have asset liability management, they have capital market debt.
Speaker 1: So there's a natural nexus. And why libar was confined
Speaker 1: only to banks again is a historical accident. And if
Speaker 1: you wanted to design it was like saying, Okay, I'm
Speaker 1: gonna design a car, and it's going to be a
Speaker 1: two wheeler like a bicycle, because everything before has two wheels,
Speaker 1: and therefore I don't care if it's a car and
Speaker 1: needs four wheels. It's like a bicycle, So let's make
Speaker 1: it a two wheeling. If you broke down almost anything
Speaker 1: you do, and if you look at inventive activity, you
Speaker 1: tailor it to what the more it needs and wants.
Speaker 1: And again we're struck by well, that's the way. You know,
Speaker 1: my grandfather used to do it, so I'm gonna do
Speaker 1: it the same way. Richard. Here's what I'm trying to
Speaker 1: still wrap my head around, because what you're saying makes
Speaker 1: a lot of sense that it doesn't necessarily benefit the
Speaker 1: country as a whole to have a lending index. That's
Speaker 1: heavily skewed towards built around the big banks, that smaller companies,
Speaker 1: real economy companies like dear local banks key for job creation.
Speaker 1: All that big said, how does it in practice? How
Speaker 1: does the use of a mirrabor your index improve actual
Speaker 1: business functioning versus some of these other benchmarks when it
Speaker 1: comes to the actual writing of loans and other deals
Speaker 1: that need some index to be built up. Two ways.
Speaker 1: I remember that the banks lend not based on a
Speaker 1: risk free rate, right, so if you if they are
Speaker 1: forced to create assets that are are risk free, then
Speaker 1: there will be volatility in their assets and liability. It
Speaker 1: will create uncertainty, it will reduce profitability, and therefore it
Speaker 1: will cause interest rates and profitability of banks to be
Speaker 1: lowered or account for the risks they take, and interest
Speaker 1: rates to be high for borrowers to reflect the increase
Speaker 1: volatility associated with running the business. It's just like competition narrows.
Speaker 1: They spread between wholesale and retail prices. And it's true
Speaker 1: for supermarkets, car dealers, and it's true for interest rates.
Speaker 1: The more you get and the more the commodity becomes homogenious,
Speaker 1: the greater the benefits to the institutions. Through higher probability
Speaker 1: and to the consumers through lower costs. It's no different
Speaker 1: than any other commodity. Richard, you spoke a little bit
Speaker 1: about adoption of a marabor. I guess I'm curious, what's
Speaker 1: the what's the next step for the reference rate to
Speaker 1: Joyce to Joe's point, when does like what would it
Speaker 1: take for adoption to really sort of take offer? What
Speaker 1: are you aiming for? Great question, You guys are super
Speaker 1: gonna smile on my day. So so in twenty eleven
Speaker 1: when we did this why experience, whether it was bond
Speaker 1: futures or as IT rate or anything, it takes a
Speaker 1: decade to develop a market. So in twenty eleven we
Speaker 1: said this is going to take ten to fifteen years.
Speaker 1: Zero to two is toddler, two to five is kind
Speaker 1: of teenager and young adult, and five to fifteen is adulthood.
Speaker 1: We're eight years into the process. We got lucky when
Speaker 1: we said ten years that the and it was no judgment.
Speaker 1: It was a stroke of luck that we called for
Speaker 1: a ten year arise and just when live or ended one.
Speaker 1: So we now have an it. This is true whether
Speaker 1: it's the personal computer you know, or or the iPhone
Speaker 1: these things take a generation to go. So we are
Speaker 1: now getting banks that are starting to price the loans
Speaker 1: that they make based on a Merra board fifty million,
Speaker 1: twenty million hred midion. They show on their graphs that
Speaker 1: they have a high correlation to the old librar, so
Speaker 1: it's very easy days to educate customers. Equally, as we
Speaker 1: have adoption of floating rate, they're using a thirty day
Speaker 1: average because they can go onto Bloomberg, they can go
Speaker 1: on to you know, any vand or or marrabor dot
Speaker 1: net see the price of this perfect transparency, and they're
Speaker 1: using a thirty day average. On June eight, we will
Speaker 1: launch a monthly futures contract on the thirty day average
Speaker 1: AMORBOR to reflect what banks are pricing loans to auto
Speaker 1: dealers in Memphis and small milk farmers in Wisconsin, me
Speaker 1: you know, hundred million dollar manufacturing companies in Arkansas. That's
Speaker 1: how the loans are going to get priced. And then
Speaker 1: once that happens, we will UH and we are educating
Speaker 1: swap dealers now who already deal with these banks to
Speaker 1: swap floating to fix um and the swap dealers will
Speaker 1: be matched with a bank whose issue they floating rate
Speaker 1: loan to a corporate, they will develop a swap. The
Speaker 1: swap will be hedged in the futures, and that is
Speaker 1: the final link in the maturity of the market. So
Speaker 1: as we see banks adopt marra bor is a benchmark,
Speaker 1: give it to corporates and small businesses on loans, then
Speaker 1: the banks go to either money center bank or a
Speaker 1: large bank to do a swap, and then that feeds
Speaker 1: the future, and then it's just a matter of replication,
Speaker 1: and we figure that's probably to to to five years
Speaker 1: we will see the ultimate broader adoption of a merabor
Speaker 1: as a benchmark um. And and again we see a
Speaker 1: world in which Sonja so for a merabor. You know,
Speaker 1: there'll be a rate in Europe, We've already educated some
Speaker 1: central bankers there, uh, and there'll be a rate in
Speaker 1: China that that the whole benchmark will be disrupted and
Speaker 1: we'll see a whole family of different rates. Alright, Richard, Well,
Speaker 1: we'll have to have you back on in a few
Speaker 1: years to talk about what's going on with the marabor
Speaker 1: um in the US and also potentially some reference rates
Speaker 1: outside of the US as well. Thank you so much
Speaker 1: for coming on off. This is my pleasure. Thank you.
Speaker 1: Your questions were intelligent, well thought out. Thank you very much.
Speaker 1: Thank you. That was great. His point about how there's
Speaker 1: no reason why you have to have a single benchmark,
Speaker 1: and it's kind of weird that for something as important
Speaker 1: as this sort of blending or interbank benchmark, that you
Speaker 1: only have a single one. I think that's really interesting.
Speaker 1: I did too. I also think it's interesting this idea
Speaker 1: of wanting a credit component in the benchmark itself, because
Speaker 1: of course so FUR it's like, the idea is that
Speaker 1: really shouldn't be much of a credit component. It's secured
Speaker 1: and so on. But then of course, if you're going
Speaker 1: to build a loan on top of SOFA that you
Speaker 1: have to calculate a credit spread or some sort of market,
Speaker 1: the market will determined to spread on top of that.
Speaker 1: So it'll be interesting to see if it makes more
Speaker 1: sense and to his point sort of a local regional
Speaker 1: company capital efficiency, if it makes more sense to have
Speaker 1: a benchmark that includes the sort of the credit conditions
Speaker 1: of the American economy overall. Yeah, and that risk free
Speaker 1: rate idea that's embedded in SOFUR, I mean that's very
Speaker 1: different to the original concept of live or and so
Speaker 1: from that perspective, you could see something like a Maribor
Speaker 1: that does include that credit risk component. You could see
Speaker 1: that trading much more close lead to Libor then, so
Speaker 1: for I think, yeah, exactly right. Of course, even if
Speaker 1: you look at on our terminal right now, you see
Speaker 1: there's a pretty big noticeable spread between Maraboror and so
Speaker 1: for as it is right now. So, uh, it will
Speaker 1: be interesting. Again. It sort of goes back to this
Speaker 1: idea of all of these things, whether we're talking about
Speaker 1: the reference rate, whether we're talking about a currency as
Speaker 1: sort of de facto social networks and or at least
Speaker 1: having big network effects. So obviously live Or had the
Speaker 1: ultimate network effect, but then it's sort of faded. But
Speaker 1: we'll see. It'll be interesting to see if Ameribor can
Speaker 1: get enough traction so that people feel value and continuing
Speaker 1: to use it, which is a good reason to have
Speaker 1: Richard back any I don't know, six months or a
Speaker 1: year or something like that. Yeah, for sure. I'm Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway, and
Speaker 1: I'm Joe wasn't All. You can follow me on Twitter
Speaker 1: at the Stalwart. You should follow our producer on Twitter.
Speaker 1: Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg
Speaker 1: head of podcast, Francesca Leavie at Francesca Today, as well
Speaker 1: as all of the Bloomberg podcast that can be found
Speaker 1: under the handle at podcasts. Thanks for listening.