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Libor alternative designed for small US banks rolls ahead with futures launch

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Libor alternative designed for small US banks rolls ahead with futures launch

A niche market operator tucked inside Chicago's famed Wrigley Building is pushing to carve out a stake in the post-Libor world.

The American Financial Exchange LLC, or AFX, first examined potential alternatives to the scandal-plagued London interbank offered rate in 2011, when reports emerged that a handful of European banks were manipulating the rate to benefit their trading positions. The misconduct ultimately led U.K. regulators to determine that the world's leading benchmark interest rate would need to go come year-end 2021.

Now, as Wall Street scrambles to prepare for life after Libor, AFX Chairman and CEO Richard Sandor is hoping to provide some solace to smaller U.S. banks with his company's latest project: Ameribor.

"We decided to build it from the bottom up with small banks, and then midsized banks and now regional banks. Clearly that's where the demand was," said Sandor, a financial markets pioneer who was an early architect of interest rate futures products, in an interview. "We do have to differentiate [ourselves]."

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Known officially as the American interbank offered rate, Ameribor is a benchmark interest rate calculated using transactions executed on the AFX's electronic-lending marketplace. There are currently 156 banks, broker/dealers, insurers and other market participants on AFX and using Ameribor, a spokesperson for AFX said.

Ameribor is one of several Libor alternatives born out of the wreckage the rate-rigging scandal left. The other rates include the U.S. Federal Reserve's Secured Overnight Financing Rate, or SOFR, and Intercontinental Exchange Inc.'s ICE Bank Yield Index. All three are transaction-based, whereas Libor is determined using a poll of about a dozen selected banks.

"We're seeing a whole family of interest rate benchmarks emerge," Sandor said. "We are a complement to SOFR, not a competitor."

Unlike its peers, AFX has designed Ameribor specifically to provide smaller U.S. banks with what it says is a more accurate picture of their actual borrowing costs. That is because Ameribor includes a credit spread component based on unsecured loans. By comparison, U.S. regulators' preferred alternative, SOFR, is a risk-free rate that is based on overnight transactions collateralized by U.S. Treasury securities. Because most small banks do not own government securities, SOFR may not reflect their borrowing costs.

"Ameribor is the closest thing to true cost of funds for a bank like Frost," San Antonio-based Frost Bank Senior Vice President Jeff Beckel said in an interview. "We're in this position today because there was only one reference rate that the market was really using. So in my opinion, SOFR should come along and so should alternative rates."

Frost Bank, a subsidiary of Cullen/Frost Bankers Inc., was one of Ameribor's original four users in 2015. The bank, which has $31.88 billion in total assets, has been using Libor since the early 1990s. But it was intrigued by the prospect of Ameribor, as Beckel and Mark Brell, an executive vice president at Frost, said the rate ultimately allows banks to lend money to each other like they did before the financial crisis. Today, Frost does between $50 million and $300 million in overnight lending on a given day, depending on its liquidity needs and rates.

As it looks ahead, AFX has recently begun building out the Ameribor-linked derivatives markets to allow users to hedge their exposures, a push Sandor hopes will lead to the swaps market. On Aug. 16, seven-day Ameribor futures contracts and three-month Ameribor futures contracts started trading on Cboe Global Markets Inc.'s futures exchange.

Launching a derivatives product is no small feat, and most do not actually trade in their early days, according to Matt McFarland, head of futures for the Cboe Futures Exchange.

But the Cboe executive said Ameribor futures have already shown promise, adding that the contracts could "take off sooner" than other futures products because of the looming transition away from Libor. The AFX and Cboe plan to roll out additional Ameribor futures contracts once the existing products are more established, McFarland said in an interview.

Through Aug. 28, there were a combined 231 contracts traded in both sets of Ameribor futures contracts, according to Cboe data, with 18 of those coming in the first day of trading. And while trading volumes have not yet met Sandor's original goal of 100 contracts per day, the AFX's chief executive said he is not worried about Ameribor's growth prospects.

"In 45 years of building markets, I've never had an immediate success," Sandor said. "Adoption is a decadelong process."