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Corrected money markets libor reform may add volatility, increase some fun

(Corrects name in seventh graph)By Karen BrettellNEW YORK, Sept 28 Libor reforms announced on Friday are seen as unlikely to cause large market shifts in the near term, though some see changes as likely to add some volatility in short-term bank funding, and push borrowing rates at least marginally higher. Some market participants also remain concerned about conflicts of interest at banks that contribute the rate and also run large interest rate swap books, despite assurances of greater regulatory oversight, as the benchmark will continue to be determined via a poll of funding costs. Britain's Financial Service Authority (FSA) delivered a 10-point plan to fix the benchmark, which underpins over $300 trillion contracts and loans, but found that rate is too entrenched to replace, and struggled to identify alternative market based measures that could be used as a substitute. The rate has lost credibility on revelations that swaps traders at large banks sought to manipulate the rate to benefit trading positions, and after banks lowballed their borrowing costs in the financial crisis in a bid to reduce fears over their credit health. An expansion of the panel of banks that submit rates to Libor, a three-month blackout on the disclosure of individual bank's lending rates and a requirement to back submissions with evidence of borrowing costs in other markets are among reforms designed to reduce attempts to manipulate the rate. It's too early to know the effect on markets of the changes, though much will depend on which banks are added to the panel."There is a lot of uncertainty over what the Libor panel will look like in the future," said Brian Smith, vice president in rates trading at TCW in Los Angeles, which manages $130 billion in assets. Many see few benefits for banks to contribute to the rate, as regulatory and public scrutiny of the process increases.

Interdealer broker ICAP said in August that it would discontinue a rate survey it had created as a substitute for Libor, due to a decline in bank participation. The European Banking Federation also launched a dollar-Euribor index earlier this year, which is meant to represent the cost of U.S.-dollar funding in the European interbank market, and the panel included none of the 18 banks that currently submit to dollar-based Libor. Friday's FSA report recommended legislation that would allow the regulator to "compel" banks to submit rates if required. MORE VOLATILITY, HIGHER COSTS

Adding more banks may push rates higher, if the panel extends to lower-rated banks and those that borrow in the short-term markets less frequently."In general I think more banks translates into a higher benchmark rate because you included banks that aren't as efficient as borrowers in the wholesale markets and tend to pay higher rates," said Alex Roever, a money market analyst at JPMorgan in New York. The requirement to reference market borrowing rates when making Libor submissions may also add to volatility in rates, said Roever, noting that volatility in Barclays Libor submissions picked up after the bank settled charges with U.S. regulator the Commodity Futures Trading Commission in June. The settlement included a requirement that the bank back up its submissions by referencing other borrowing rates including its commercial paper and certificates of deposits, and with reference to markets including overnight index swaps, futures, and repo."The change increased the volatility of Barclays submissions, at least temporarily, I think in part because they are living more under a microscope," said Roever.

FIGHTING OVER FRACTIONS Some market participants, however, remain concerned that swaps traders may continue to try to influence Libor settings, as even minute changes can drive large gains or losses for banks with interest rate derivatives positions based on the rate that can be in the hundreds of billions of dollars. As an example, take a bank that owes a trading partner quarterly payments on a $50 billion portfolio of derivatives. Here, a move as minute as one-tenth of a basis point in three-month Libor, or one-thousandth of a percentage point, will represent around $125,000. That means the bank will gain or lose $1.25 million for each one-basis point change in the rate. For some traders, the temptation to hold swap over the setting may be too much."It may just create a better thief," said one former swaps trader at a bulge bracket bank. In this respect, the precision of Libor settings is an issue. Banks report rates out to five decimals of a percentage point in Libor, while short-term lending in markets including commercial paper more typically rounds out to three decimals of a percentage point."The system delivers on a daily basis a very precise measure of a market that actually doesn't trade that much, or isn't observable, and is an opinion poll," the trader said."It's ripe for error, it's a difficult task to perform accurately on a daily basis because of the design," he said.

Corrected oman plans islamic finance rules before year end

(Clarifies last paragraph attributed to Rafique)By Bernardo VizcainoSYDNEY, June 27 A regulatory framework for Islamic finance is taking shape in Oman as government bodies move towards meeting the country's stated aim of making sharia-compliant products available to the public this year. But logistical challenges and the limited size of the market may prevent entrants to the business from making quick profits. Legislation covering takaful (Islamic insurance) and sukuk (Islamic fixed income securities) is expected to be finalised by the end of the third quarter of the year, Capital Market Authority officials told Reuters. Approval of the country's first takaful licence will follow soon afterwards, as three applications have already been received by the regulator, Ahmed Al Harrafi, takaful team leader at the CMA, said by telephone. This complements efforts by the country's central bank to introduce a law that will supervise Islamic banks; the law is in its final stages of review, said Mohammed Al Abri, senior director at the CMA. Last year, after insisting for years that its banking industry should be purely conventional, Oman reversed its stance and said it would introduce Islamic finance, partly to prevent outflows of funds to sharia-compliant institutions elsewhere in the Gulf. But the introduction of the regulatory framework may not produce a rapid surge of activity. Many institutions are still grappling with the need to obtain product expertise, arrange oversight by boards of Islamic scholars, train staff and build computer systems."There is an expectations mismatch," Azmat Rafique, head of Islamic banking at Oman Arab Bank, told Reuters. "On the ground things haven't been finalised...and banks are still gathering teams and systems."Last week newly formed Bank Nizwa, the country's first Islamic bank, failed at a shareholders meeting to appoint its board of directors, despite an initial public offer of shares that raised 60 million rials ($156 million) last month. This could potentially delay its schedule for launching products.

COMPETITION Also, banking competition will be stiff. Bank Nizwa obtained its banking licence last year along with Al Izz International Bank, another new Islamic institution; they will bring the total number of locally incorporated banks to nine. Oman will thus have 19 commercial banks for a population of only about 2.8 million, with the three largest lenders initially accounting for about 60 percent of total banking assets, according to central bank data. Competition will be increased by the fact that conventional banks will be allowed to use Islamic windows to offer sharia-compliant products through their existing branch networks. Bank Muscat, which has Oman's largest branch network of 130 offices, this week joined Bank Sohar and National Bank of Oman in saying it would deliver products this way.

Converting some existing conventional banks into Islamic banks could streamline the broad banking industry, but the central bank has not indicated whether this will be permitted, commercial bankers said. The industry may in any case not be advanced enough to handle such conversions, said Rafique. Recent consolidation in the banking sector has been limited to a merger of HSBC's Omani business with Oman International Bank, the country's fifth largest lender, which obtained approval earlier this month. Rafique predicted 10 percent of existing bank customers in Oman would eventually make the switch to Islamic banks, which would also attract a similar number of people who are currently outside the banking sector because of their religious belief in avoiding interest.

TAKAFUL The takaful legislation, on the other hand, will not allow the use of Islamic windows but instead require stand-alone operations with paid-up capital of 10 million rials, Al Harrafi said. But such capital requirements are difficult to justify in a sector eager to build scale, said Shyam Zankar, regional head at Bahrain-based Medgulf Allianz Takaful. In addition, takaful companies will also have to be publicly floated on the country's stock exchange within five years of launch, Al Harrafi said, adding that this requirement might dampen the interest of at least one of the applicants. Two firms have begun headhunting for senior positions in anticipation of entry into Oman's takaful market, said a Gulf-based chief executive of an insurance firm, who asked not to be named. STANDARDS In the area of monitoring Islamic product standards, Oman is opting for the decentralised approach which prevails in the Gulf, rather than the centralised Malaysian model. This could facilitate early growth of the industry, by permitting a wider range of competing products, but perhaps limit broad interest in Islamic finance across the population because of the lack of a single, commonly accepted sharia board overseeing the industry. The CMA, which became a member of the Malaysia-based Islamic Financial Services Board in March, considered creating a centralised sharia supervisory body but this option was not chosen, Al Harrafi said. An Islamic banking circular from Oman's central bank urged each bank to establish its own sharia board. The standards of the Accounting and Auditing Organisation for Islamic Financial Institutions, a Bahrain-based industry body, will be used as guidelines by the central bank, Rafique said, adding that only the accounting standards are mandatory.