Since the autumn of 2012 the Hungarian Financial Supervisory Authority (HFSA) has conducted investigations at 17 Hungarian credit institutions regarding the practice of setting the Budapest interbank offered rate (BUBOR).The investigators have made recourse to using information from ACI Hungary (Magyar Forex Társaság – MFT), which sponsors the formation of BUBOR, as well as from Magyar Nemzeti Bank (MNB), which possesses information on the quotes. HFSA launched its investigation after UK FSA and USA Commodity Futures Trading Commission (CFTC) announced in the summer of 2012 that Barclay’s Bank had manipulated the euro interbank interest rates (EURIBOR), as well as the GBP and USD LIBOR interest rates.

The statistical analysis prepared by HFSA experts has confirmed that in the past none of the Hungarian banks had intentionally diverted the BUBOR value, i.e. it fitted the curve of the basic interest rate of the central bank. However, the investigation also revealed that the setting procedure was not and is still not regulated at banks responsible for setting BUBOR (as of 1 February 2013 only 10 active quoting banks are present on the market), it is not incorporated into their risk management systems, and the relevant control mechanisms are absent, as well. Furthermore, the credit institutions concerned do not have in place internal regulations for the methodology and operative conduct of quoting, or for checking and archiving the submissions, as well as the results of the quotes. The BUBOR regulation compiled by ACI Hungary did not provide a detailed methodology guideline either. In addition, it did not even contain a definition for BUBOR.

Based on the comprehensive investigation, HFSA concluded that the credit institutions involved in setting the BUBOR rates failed to develop built-in-process governance mechanisms. In the absence of methodological guidelines they relied on the specific professional experience and rigour of individual traders making or preparing the quotes. The market risk management processes did not include checking the quotes, no inquires were made about bad quotes, and no corrections were initiated either. The internal procedure was not investigated by the internal auditors or external auditors of the banks concerned, and no executive reports were prepared either. After the emergence of the LIBOR scandal a few banks have conducted internal audits and started the compilation of internal regulations upon the initiative of their parent banks.

In contrast with other similar benchmarks, the uniqueness of BUBOR, i.e. the national interbank interest rate, lies in the fact that MNB undertakes a consolidating role in the quoting procedures. This has suggested to the market that due to the continuous involvement of an authority, BUBOR fixing is an activity that is kept under public control throughout the procedure. However, MNB’s contribution has basically been limited to totalising the daily quotes and calculating the interest rates, and it had no controlling role any manner.

HFSA has already formulated its requirements for making up the deficiencies and strengthening the system in so-called investigation letters, but it will soon publish them in a public recommendation. Consequently, the concerned banks will have to regulate the quoting procedures, establish appropriate control points, incorporate this activity into their risk management systems, and must ensure that the quotes are regularly checked by and reported to the management. HFSA will check compliance with these requirements again during its future comprehensive investigations.

Furthermore, HFSA has suggested that ACI Hungary should compile a Code of Conduct for those involved in making the quotes with provisions relating to sanctioning the violation of the rules and that the Policy Committee of ACI Hungary should include independent experts nominated by HFSA and Government Debt Management Agency.

BUBOR is a determining element of the Hungarian money and capital market, and according to HFSA’S analysis, it cannot be replaced by any other benchmark. Its importance is indicated by the fact that on 30 June 2012 nearly HUF 2,500 billion worth HUF loans and HUF 600 billion deposits were priced on the basis of Budapest interbank offered rate, and nearly twenty legal regulations in force refer to BUBOR. On the other hand, the number of credit institutions quoting the interbank interest rate is decreasing and the quotes are not backed by real interbank dealings (while the index is linked to a significant amount of loans and deposits). In addition, the interbank market has significantly shrunk following the liquidity crisis of 2008. Consequently, BUBOR has not fulfilled the objective of giving the money and capital markets accurate information on underlying deals.

In order to restart the trading, HFSA recommends the extension of the interbank limits, the introduction of mandatory trading (through the introduction of two-sided, bid/offer quotes), as well as the creation of voluntary quoting obligation for active price-quoting banks. In parallel with this, it is recommended to reduce reasonably the number of quoted maturities, (e.g. overnight, 1 and 2 weeks, 1, 3, 6 and 12 months). It is also recommended that ACI Hungary should determine the key maturities and the frameworks for the standard application thereof. Due to the decreasing number of quoting banks and in line with the international practice, HFSA has initiated the development of the BUBOR averaging methodology. According to that technique, instead of disregarding the highest 4 and lowest 4 quotes, the extreme quotes given by 25 percent of the participants are taken out of the calculation of BUBOR.

Should the number of quoting banks continue to drop, HFSA may be compelled to take regulatory measures, for example to prescribe the quoting requirement in the form of legally binding regulation.

Since the European Commission is already working on a new proposal regarding benchmarks, that proposal shall be taken into account when drafting the Hungarian regulations. The European Commission is expected to put forward its proposal in the third quarter of 2013.