Libor, for anyone unfamiliar with the world of money, stands for the London Interbank Offered Rate and is the average interest rate banks pay when borrowing from other banks.

More importantly, it is the king of interest rates because Libor is the benchmark on which all other interest rates are set with more than $US350 trillion in financial products worldwide based on Libor – including your home mortgage and car loan.

Libor, however, once had a problem in that some clever kids in London worked out a way to

“game” it, causing the rate to fluctuate by small amounts in either direction, to know what that direction was and to profit from tiny movements which, in a $350 trillion market, is easier than it sounds.

The game worked with Libor (and also for fixing foreign exchange rates) because Libor was based the oldest of British ways of striking a price for a widely traded financial product or commodity – the “chaps” would compare notes after a busy day and agree on a mid-point, assuming that everyone was telling the truth.

Perhaps 100 years ago, just perhaps, everyone fixing an interest rate, or foreign exchange rates, or setting the benchmark price for gold, was telling the truth thanks to that wonderful motto of The City: “my word is my bond”

Anyway, what happened with Libor when trust broke down sounds to The Hog alarmingly similar to what might have been happening with the Newcastle and Richards Bay coal prices, the two key coal markers for Australian and South African coal.

Macquarie Bank in a report published a few days ago took a close look at the need to reform the way coal prices are set.

The bank noted that thermal coal price benchmarks had come under criticism with market participants claiming that “pricing methodologies leave avenues for dominant producers/traders to push market prices higher than wider market fundamentals warrant”

“We think this was evident in Newcastle price action earlier this year and more recently has been seen in the Richards Bay market too,” the bank added.

Macquarie said that in response to the “swell of opinion” the world’s largest physical coal broker and screen trading-platform, globalCOAL, has announced changes to the rules on physical Richards Bay trading and is seeking feedback on its Newcastle index.

There is not sufficient space or time to detail what’s happening with the reviews except to note that each market trades in a slightly different way and that there is a separate discussion underway over coal quality and the in calorific values.

However, what jumped out of the Macquarie work were those spikes in the reported Newcastle price earlier this year and two spikes in the Richards Bay price.

“The Newcastle price benchmark was clearly forced higher by a trader squeeze ahead of the Japanese Fiscal Year contract negotiations in the first quarter,” the bank said.

“The method of operation at that time was for a dominant player to buy physical tonnes through globalCOAL, in small sizes, at massive premiums to the prevailing paper price.

“At the peak, the premiums exceeded $11 a tonne.”

Translated from financial talk into plain English it can be argued that someone “gamed” the coal market using the system to manipulate the coal price.

Macquarie noted that globalCOAL was acting to resolve the problem with fresh restrictions on the size of transactions with the new rules in place until the end of the year

when “the functioning of the market will be re-examined.”

“We view this as a positive development and think methodology reviews should be an ongoing process to maintain integrity in both the physical and derivatives market,” the bank said.

What Macquarie has done is throw a little light into an obscure corner of the coal market because what happens in the Newcastle and Richards Bay markets also influences the price paid for coal exported from other countries, such as Indonesia.

Two final points are worth making about what is a remarkably complex subject.

The first is to echo what Macquarie said in its opening observation that it’s time to “get the ball rolling on thermal coal pricing reform”

The second is to point out that if the coal industry doesn’t get its own house in order someone else will do it – and that’s when things can get awfully messy.

In the case of Libor, the biggest and worst example to some people not playing by the rules the resulting fines for manipulating the interest rate and foreign exchange markets were spectacular.

Barclays Bank copped the biggest penalty, a cool $2.38 billion. Citigroup had to cough up $1.27 billion. When a deal was struck earlier this year, six leading bank were forced to pay fines totalling $6 billion for their market rigging operations.

It will be interesting to see where the coal market goes because those spikes on graphs plotting the Newcastle and Richards Bay coal prices have a rather guilty look to them.