The UAE wanted to inoculate its banking benchmark against manipulation after Europe’s rate-rigging scandal.
The result: a lending reference rate so volatile it’s a challenge to derivatives traders.
Under the new method implemented last year, the Gulf state’s central bank gives priority to data from actual executed transactions between lenders and large companies. Previously it relied largely on estimates to determine the rates they would charge each other for short-term loans.
The Emirates Interbank Offered Rate underpins many dirham-denominated loans and is also a benchmark for derivative products such as swaps, used to hedge against floating interest rates. After the changes, the Opec’s third-biggest producer ended up with an official reference rate whose spread over Libor has swung in the past month from eight basis points to minus 22, according to data compiled by Bloomberg.
The central bank now calculates the three-month Eibor, used to price billions of dirhams worth of debt each year, as the average of submissions by eight banks operating in the UAE, including the local units of HSBC Holdings Plc and Standard Chartered Plc, after excluding the two highest and lowest quotes.
But a much smaller sample size has made the reference rate far more volatile. The average daily percentage change has risen by more than half to 0.2% in the past 12 months from 0.13% in the preceding period, according to data compiled by Bloomberg. The interbank rate dropped two basis points to 2.87% on Thursday.
“It makes products priced off the Eibor more volatile, affects lending decisions, derivative products and hedging,” Anita Yadav, the head of fixed-income research at Emirates NBD PJSC, the UAE’s second-biggest bank, said by phone. “It makes it harder to trade some of the derivative products because it reduces the predictability of the spread.” It has risen 3 basis points this year after climbing 104 basis points last year. The central bank went ahead with the shift last year despite a warning that the Eibor could become more volatile as a result. The change was planned as the Federal Reserve sought to raise borrowing costs further. The UAE. typically follows US monetary policy decisions because its currency is pegged to the dollar. The central bank in Abu Dhabi didn’t respond to a request for comment.
European benchmarks were open to manipulation because they relied on banks’ estimates of their own borrowing costs. Global lenders have paid steep fines for rigging Euribor and the better known Libor to mask their true cost of borrowing or to profit from trading positions.
The new approach means “variations in the transactions, and sometime the limited numbers of them, contribute to this volatility,” Monica Malik, the chief economist at Abu Dhabi Commercial Bank PJSC, said by phone. “The volatility is noticeable on a daily basis, which would have some implication for the trading of derivative products.”