The benchmark London interbank offered rate (LIBOR) is broken and will receive “a complete overhaul”, including a reduction in the number of rates that it offers according to Martin Wheatley, managing director of UK regulator the Financial Services Authority (FSA).
“Today we press the reset button,” said Wheatley, in a speech to mark the launch of his government-commissioned report. “LIBOR needs to get back to doing what it is supposed to do, rather than what unscrupulous traders and individuals in banks want it to do.”
However, he said that despite its faults the FSA does not propose to scrap LIBOR, which is so deeply entrenched in the financial system that it cannot be easily replaced. There are currently no better alternatives and any transition to a new benchmark would be difficult, although longer term it makes sense for market participants to review whether other benchmark rates could be substituted.
Reforms to LIBOR outlined by Wheatley in his report include a 10-point plan that would involve the dropping of five currencies and reducing the number of daily fixings from 150 to just 20. The reductions would enable rate-setting banks to focus on the rates and currencies most used by investors and borrowers.
Other proposed reforms include auditing banks that contribute data used to calculate the rates, to ensure they are not submitting false rates to benefit trading positions. The benchmark, which is meant to reflect the rates at which banks borrow from one another, will be based on actual borrowing transactions. Previously, banks could estimate where they think they would borrow, which left room for manipulation.
Transactions will be recorded with regular external audits of participating banks, and employees making LIBOR submissions will have to be approved by the FSA. Wheatley is seeking authorisation to criminally sanction those who attempt to manipulate the rate. He said that society wanted people who committed such acts to “pay the price, and if that includes jail for the most extreme fraud in the system, then that’s what should happen”.
Wheatley added that he had taken legal advice and does not expect a rash of legal disputes or any disruption in the transition to a new system, as there will be no change to the definition of LIBOR and no change to the timing or mechanism for submitting quotes.
“Society has lost confidence in banks… and we need to restore that,” he said. As expected, the British Bankers’ Association (BBA), which had overseen the benchmark rate, would be replaced with a new, as-yet unidentified oversight panel. “The BBA clearly failed to properly oversee the LIBOR setting process and should take no further role in the administration and governance of LIBOR,” Wheatley said.
The BBA, which earlier this week indicated that it
its demotion, said it worked closely with Wheatley on his review and had strongly stated the need for greater regulatory oversight of LIBOR and tougher sanctions against manipulation.
The FSA’s recommendations were welcomed by lobby group the Confederation of British Industry (CBI). “Bringing Libor under an independent regulator will take away the notion that this was a system run by banks for the benefit of banks,” said Matthew Fell, its director for competitive markets.
“Focusing it on the most liquid trades will drastically reduce the scope for any manipulation, particularly at times of market stress.”
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