Oversight of Libor will be handed to the U.K.’s financial regulator, and dozens of the currencies and maturities that make up the benchmark axed, under proposals designed to revive confidence in a rate tarnished by scandal.
The British Bankers’ Association should be stripped of the responsibility for managing the rate and other organizations invited to replace it, Financial Services Authority Managing Director Martin Wheatley said in London today. More than 100 Libor rates tied to currencies and maturities where there isn’t enough trading data to set them properly should be scrapped, and a code of conduct introduced for how lenders contribute to the benchmark backed by criminal penalties, he added.
“Governance of Libor has completely failed,” Wheatley said as he unveiled a report on the future of Libor. “This problem has been exacerbated by a lack of regulation and a comprehensive mechanism to punish those who manipulate the system.”
Wheatley began his review at the request of Chancellor of the Exchequer George Osborne after Barclays Plc, Britain’s second-biggest lender, paid a record 290 million-pound ($470 million) fine in June for manipulating the London interbank offered rate, used to set rates for more than $300 trillion of securities.
The FSA should receive greater powers to vet bankers who contribute to the rate, according to Wheatley, who will become the chief executive officer of the Financial Conduct Authority when the FSA splits into two agencies next year.
He stopped short of advocating scrapping Libor, saying that would be too disruptive to borrowers whose existing contracts reference the rate.
“Repealing Libor was just not an option,” said Simon Maughan, a banking analyst at Olivetree Securities Ltd. in London. “He’s done the right thing here,” he said. “Improve it, make it based on real transaction costs, get rid of some of the currencies, that seems like a sensible approach.”
Libor is calculated by a poll carried out daily by Thomson Reuters Corp. on behalf of the BBA, a banking industry lobby group, that asks firms to estimate how much it would cost to borrow from each other for different periods and in different currencies. The top and bottom quartiles of quotes are excluded, and those left are averaged and published for individual currencies before noon in London.
The FSA will encourage more banks to submit quotes as part of the revamp, Wheatley said, and could force uncooperative banks to submit quotes with its new powers.
The number of Libor reference rates should be cut to 20 from 150 within a year by phasing out currencies and maturities in which trading is thin, Wheatley said. Publication of Libor for Australian, Canadian and New Zealand dollars, as well as the Danish Kroner and Swedish Kronor should be ended, he said.
Four-month, five-month, seven-month, eight-month, 10-month and 11-month rates should be axed, while eliminating one week, two-week, two-month and nine-month tenors should also be considered, according to the proposals.
Banks will also have to follow a code of conduct governing how they make their daily submissions. Rate-setters will have to base their inputs on a hierarchy of data points, starting with any actual transactions in the unsecured inter-bank deposit market, he said. Where none exist, banks should then consider any borrowings in other instruments including commercial paper, repurchase agreements and overnight-index swaps.
Wheatley also proposed banks wait three months before disclosing publicly their own Libor submissions. To rectify the “reduction in immediate transparency” he recommended lenders publish a regular bulletin that includes trading volumes.
The “first priority” of Libor’s new administrator will be to create a code of conduct for rate submitters with specific guidelines that the submissions be corroborated by trade data, he said.
“Transactions will need to be recorded and there needs to be a requirement for regular external audit of submitting firms,” Wheatley said.
The tender process to take responsibility for setting Libor will start next week and be run by an independent committee led by Sarah Hogg, the chairwoman of the Financial Reporting Council. Wheatley said the bidding should take about three months.
The BBA’s role as guardian of Libor has been under pressure since the Bank for International Settlements first raised concern in 2008 that the benchmark was being manipulated.
The new manager of the Libor rate should be “an “organization that won’t be conflicted, like a trade association would be,” Wheatley said.
At least a dozen banks are being probed by regulators worldwide over allegations they colluded to manipulate the benchmark to profit from bets on derivatives.
“Many respondents thought that the current position of the BBA is untenable due to its loss of credibility from past involvement in Libor and its vested interest in defending the banks,” the report said. “The BBA acts as the lobby organisation for the same submitting banks that they nominally oversee, creating a conflict of interest that precludes strong and credible governance.”
“With Libor being such an intrinsic part of the financial system, restoring trust in it is an important step towards the broader task of rebuilding confidence in banking,” Matthew Fell, director for competitive markets at the Confederation of British Industry, said in an e-mail. “Bringing Libor under an independent regulator will take away the notion that this was a system run by banks for the benefit of banks.”
Other benchmarks, such as for the prices of agricultural products, oil and precious metals, and in the equity, bond and money markets, should be looked at as well, Wheatley said.
The European Union, which is conducting its own review of interest-rate benchmarks, including Euribor, said that any solution must apply across a wide range of markets.
“Concerns about benchmarks are not limited to interest rate benchmarks, but extend to all kinds of benchmarks, including commodity and benchmarks for other markets,” the EU said in a statement.
Dan Doctoroff, CEO of Bloomberg LP, has proposed an alternative to Libor dubbed the Bloomberg Interbank Offered Rate, or Blibor. It would use data from a variety of financial transactions to better reflect participating banks’ real cost of credit. Bloomberg LP is the parent of Bloomberg News.