Law, Interbank, and Money Markets: Has LIBOR price manipulation risk been replaced by SOFR volatility risk?

Law Review: Has LIBOR price manipulation risk been replaced by SOFR volatility risk?

Investopedia, a finance news website, defines a reference rate as an interest rate benchmark designed to set other interest rates. Reference rates may be found in mortgage agreements and sophisticated mortgage rate swaps. They act as benchmarks for the performance of a securities and financial contract.

According to the Federal Reserve Bank of New York, reference rates provide the central bank system with insights into how money markets are performing and how well monetary policy is being implemented. Specifically,

“They facilitate trading in standardized contracts, which can lower transaction costs and improve market liquidity. They can reduce information asymmetries by providing a transparent, independent pricing source. And a well-designed, robust reference rate that is resistant to manipulation can limit participants’ incentives to misreport pricing for settling a contract.” — Federal Reserve Bank of New York.

Hedge funds, private equity funds, proprietary trading firms, and retail traders are at a disadvantage when trading with banks serving as counterparties. The interbank market, from my observation, is a walled-off garden within which banks may collude to either fix reference rates that act as benchmarks in a financial or securities contract or increase bid-ask spreads before selling a trader a contract.

For example, in Sonterra Capital Master Fund, Ltd vs. Credit Suisse Group AG, the plaintiffs made a general allegation that twelve panel banks colluded to manipulate the now defunct London InterBank Offered Rate for the Swiss Franc, moving the reference in directions that benefited counterparty banks. The banks made false submissions to their traders where the banks asserted that the rates they offered were rates that they would expect to charge for lending in the overnight market. The plaintiffs asserted a number of specific actions taken to manipulate reference rates, including:

1. Intra-dependent manipulation, where a defendant bank would receive a request from its own trader to submit a false reference rate;
2. Inter-dependent manipulation, where a defendant bank received a request made by another defendant bank to submit a false reference rate;
3. A deep decrease in benchmark rates increases the price or value of a contract.
4. There is a discrepancy between benchmark rate and rate of borrowing in actual money markets.
5. Requests that reference rates be set on specific days.
6. Requests for false rate submissions that provided longer-term biases.
7. Implementation of lax compliance standards.

LIBOR’s manipulation particularly between 2001 and 2011 led to its replacement by the Secured Overnight Financing Rate (SOFR). While the LIBOR was based on an estimate of the interest rate that banks would lend each other money, SOFR is based on the cost of borrowing money overnight where the borrowing is collateralized by U.S. Treasurys. Use of actual transactions in the market, transactions collateralized by government debt, makes SOFR a more dependable measure.

But does this mean that SOFR is without risk? While legal risks of price manipulation seem to have been greatly mitigated, SOFR still faces volatility risks. SOFR, because it is based on daily market transactions, faces daily volatility due to intra-day spikes in Treasury yields. Its daily publication means that there is a transmission of news regarding intra-day rate movements. The transparency in prices of the securities that collateralize SOFR leads me to conclude that volatility should not be, ceteris paribus, a source of legal risk.

Alton Drew

17 March 2025

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The Data.

Administered rates per the Board of Governors of the Federal Reserve System.

Discount Window: 4.50%

Effective Federal Funds Rate: 4.33%

Interest on Reserve Balances: 4.40%

Overnight Reverse Repurchase Facility Rate:4.25%

Reference Rates per the Federal Reserve Bank of New York.

Effective Federal Funds Rate:4.33%
Overnight Bank Funding Rate: 4.33%
Secured Overnight Financing Rate:4.30%
Broad General Collateral Rate:4.29%
Tri-Party General Collateral Rate:4.29%

Foreign exchange rates per the Board of Governors of the Federal Reserve System.

EUR/USD=1.0872
USD/JPY=148.5100

Treasury rates per the Department of Treasury.

2-yr notes: 4.06%

10-yr notes: 4.31%

30-yr bonds: 4.60%