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India quick off mark for benchmark reform

HONG KONG -- Regulators worldwide are scrambling to find better ways to set key financial benchmarks in light of a series of scandals. India, long hampered by the deficiencies of its own benchmarks, has emerged as an unlikely trailblazer.

     Under the current timetable, India is about to become the first country to have both foreign exchange and interbank lending rates set by a neutral administrator.

     Other countries have also announced changes to their rate-setting mechanisms after global banks were fined billions of dollars for colluding to fix the London Interbank Offered Rate, or Libor, a benchmark for short-term loans between financial institutions. There have also been widespread investigations into similar illegal behavior in foreign exchange trading.

     Under new principles outlined by the International Organization of Securities Commissions -- the Madrid-based global regulator of securities markets -- Japan and Hong Kong have transferred the administrative function of setting interbank lending rates from banks to financial industry bodies and introduced stricter oversight. Singapore wants to create a similar administrator that is independent of the banks. But Indian regulators are moving faster than most.

     Crucially, the Reserve Bank of India has indicated that it wants interbank rates to be based on market data, rather than daily polls of a panel of banks -- a common global practice that creates opportunities for manipulation. And while other central banks are still debating the pros and cons of polling, India is also moving ahead with foreign exchange reform. Most countries are holding back amid ongoing investigations into alleged manipulation of the $5.3-trillion-a-day forex market.

     The RBI announced in April that a new committee comprising members not involved in financial markets, such as retired judges and civil servants, will be formed in the next six months to administer interest rate benchmarks. Either the same committee or a separate one will be in charge of administering forex fixing.

     D.V.S.S.V. Prasad is chief executive officer of the Fixed Income Money Market and Derivatives Association of India, the industry body that currently administers the benchmark Mumbai Interbank Offered Rate, known as the Mibor. He said the new arrangement would segregate the administration side of interbank lending rates -- the computing and publishing of the Mibor -- from the bankers who submit the quotes and eliminate any conflict of interest.

     That the same change is being made for Indian rupee-dollar fixing is a sign of the central bank's determination to overhaul the whole onshore foreign exchange market. At the moment, the main reference price for the rupee against the dollar is set by the central bank every day -- an alternative to the industry-led spot price published by the Foreign Exchange Dealers' Association of India. Out of a panel of 25 active banks, the central bank randomly picks six to 10 between 11:45 a.m. and 12:15 p.m. and publishes the average of their quotes. The average is used to price cross-border trade contracts and foreign exchange derivatives.

     The dealers' association rate, in contrast, is calculated from data collected from all the banks.

     The RBI rate is considered more robust because the random choice of banks each morning makes collusion harder. Secondly, since there is a time range rather than a specific time at which the quotes are polled, it is trickier to manipulate the quotes by submitting a large number of orders ahead of time.

     Still, the central bank wants to hand over the main forex fixing duties to the market one day, and the current reform prepares the industry to play a bigger role. But the RBI concedes that it will take time for confidence to build up after the recent scandals, and it will continue to publish its official rate for the time being.

Job for the markets

G. Mahalingam, principal chief general manager of the RBI's financial markets department, says the central bank wants the daily forex rate to be based purely on market data and that the poll-based RBI reference rate will be discontinued eventually.

     "We would like to get out of it over a period of time," he said. "It is not really the job of the central bank to publish benchmarks. We think it should be done by market associations and participants."

     Industry players are hoping the RBI's reform will ultimately help drive economic growth. The country lacks a robust loan market, the corporate bond market is almost nonexistent, and as much as 50% of rupee trading was estimated to be taking place in offshore markets as of mid-2013.

     Prasad thinks that by strengthening the administration of key rates, a lot of offshore trading will move back onshore. However, this optimism has not reached all corners of the financial industry.

     The main reason the offshore market has grown so large is because the rupee is only partially convertible and the country has capital controls in place. As a senior player in the Indian fixed-income market also points out, the current reform does not address a major problem for companies trying to raise funds: There is simply no widely used benchmark for pricing loans and bonds.

     The rate reform process is at an early stage around the world. It is particularly daunting for India, given its relatively small money and interbank loan markets. But as the country expects more liberalization and accountability under its new government, investors are hoping that the central bank's reforms will usher in a new era for the Indian capital markets.

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