After being rigged by some of the world's biggest financial institutions, the London interbank offered rate, the benchmark for more than $300 trillion of securities and loans, is now increasingly being set by a smaller group of banks.

Bank of America Corp., Citigroup Inc. (C), Bank of Tokyo Mitsubishi UFJ Ltd., Royal Bank of Canada, Sumitomo Mitsui Financial Group Inc. and Lloyds Banking Group Plc (LLOY)'s submissions have been used in setting the rate on an almost daily basis in the past four months, data compiled by Bloomberg show. Two years ago, none of the 18 designated lenders made it into every fixing of the measure, which excludes outliers by stripping out the four highest and lowest contributions.

“You have a core group setting the rate and that's a major concern,” said Bret Barker, a money manager at Los Angeles- based TCW Group Inc., which oversees $128 billion. “It's going to be very tough to fix that and very tough to replace Libor.”

While Libor is supposed to represent the interest rates banks pay each other for short-term loans, the dominance of a smaller group shows the measure is failing to accurately reflect the true health of the financial system and borrowing costs.

The U.K.'s Financial Services Authority recommended Sept. 28 that Libor have a broader group of contributors, while acknowledging that developing an alternative would be too disruptive to borrowers around the world because the rate is so embedded in the financial system. Libor's use stretches from U.S. adjustable-rate mortgages and floating-rate bonds to over- the-counter derivatives including interest-rate swaps.

Traders have said for years that Libor was being rigged. Those suspicions were confirmed in June, when Barclays Plc (BARC), Britain's second-biggest lender by assets, paid a record 290 million-pound ($468 million) fine for manipulating the benchmark. Bloomberg News has found that at least a dozen banks are being probed by regulators worldwide for allegedly colluding on Libor submissions to profit from bets on derivatives.

“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, the director for competitive markets at the Confederation of British Industry, said in an e-mail on Sept. 28 after the FSA and Managing Director Martin Wheatley released their findings of an investigation into the benchmark.

Small Group

Libor is calculated by Thomson Reuters Corp. on behalf of the British Bankers' Association, with rates published daily for 10 currencies over 15 maturities. Compilers discard the four highest and lowest quotes and average out the remaining 10.

Three-month dollar Libor, the most commonly used of the rates overseen by the BBA, ended last week at 0.35125 percent, down from 0.58250 percent at the start of the year.

Submissions by Bank of America, Citigroup, BTM and RBC were used in all 87 of the fixings in the four months since June 6, data compiled by Bloomberg show. Sumitomo's were used on all but one day, and Lloyds's on all bar two, both last week.

Citigroup kept its estimate unchanged at 0.45 percent until the end of July, when it began reducing it to 0.34 percent as of Oct. 5. BTM held its submission at 0.46 percent until July 27, before reducing it to 0.35 percent by last week, while Bank of America didn't move its estimate from 0.47 percent until Aug. 2. It submitted a rate of 0.39 percent on Oct. 5.

Victoria Garrod, a spokeswoman for Bank of America in London, declined to comment, as did Jeffrey French at Citigroup Lloyds is “assisting various regulators in their on-going investigations,” London-based spokeswoman Nicole Sharp said.

HSBC Holdings Plc held its submissions for three-month dollar Libor at 0.25 percent since Sept. 14, and after offering the lowest estimates since August 2011 hasn't been included in the calculation at all over that period, data compiled by Bloomberg show.

At the top end of the submissions, French lenders Societe Generale SA (GLE), which quotes borrowing costs of 0.46 percent, and Credit Agricole SA (ACA) at 0.495 percent, haven't been included in the past four months.

Brendan McNamara, a spokesman at HSBC in London, declined to comment. Nathalie Boschat, a spokeswoman for SocGen, and Anne-Sophie Gentil at Credit Agricole, both in Paris, also wouldn't comment.

Drying Up

Unsecured lending between banks — the activity Libor is designed to reflect — has dried up as institutions increasingly demand collateral before money changes hands or go to central banks for funds. As a result, banks' reported borrowing costs have diverged, meaning the same group of lenders is dominating the middle ground where the benchmark is set.

The gap between the highest and lowest submissions has widened from before the scandal, reaching an average 0.32 percentage point in the past four months, compared with 0.1 percentage point in the same period of 2011, data compiled by Bloomberg show.

The century-old BBA, which represents more than 200 banks and lobbies policy makers and regulators on their behalf, helped introduce Libor in January 1986 to cement London's dominance in the markets for syndicated loans and interest-rate swaps.

Speculation rose at the height of the financial crisis in 2008 that some panel members were submitting inaccurate information for Libor to mask their true borrowing costs and avoid being viewed as troubled.

Proposed alternatives have failed to gain traction. ICAP Plc (IAP), the largest broker of transactions between banks, discontinued its daily survey of New York unsecured funding rates in August after consistently receiving insufficient submissions.

Dan Doctoroff, President and Chief Executive Officer of Bloomberg LP, has offered a measure dubbed the Bloomberg Interbank Offered Rate, or Blibor. It would use data from a variety of financial transactions in an effort to better reflect participating banks' real cost of credit. Bloomberg LP is the parent of Bloomberg News.

The BBA should be stripped of the responsibility for managing the rate and other organizations invited to replace it, Wheatley said in unveiling the results of his report on Sept. 28. He recommended a code of conduct backed by criminal penalties for how lenders contribute to the benchmark.

Other measures proposed include encouraging more firms to put in quotes and allowing the FSA to force uncooperative banks to make submissions.

'Completely Failed'

“Governance of Libor has completely failed,” Wheatley said. “This problem has been exacerbated by a lack of regulation and a comprehensive mechanism to punish those who manipulate the system.”

Financial Secretary to the U.K. Treasury Greg Clark said the government will move at the “maximum possible pace” to overhaul oversight of Libor and will give a formal response next week.

The BBA is focusing on the “ongoing regulatory and governmental investigations and inquiries,” said Brian Mairs, a spokesman for the lobby group. The priority “is to ensure the provision of a reliable benchmark which has the confidence and support of all users, contributors and global regulators,” he said.

“We just might get a better process with less room for subjectivity,” said Paul Smillie, a global banks analyst in Singapore at Threadneedle Asset Management, which oversees about $45 billion of fixed-income assets.

Elsewhere in credit markets, a gauge of U.S. corporate credit risk fell every day last week as a better-than-forecast jobless report boosted optimism about the world's largest economy, while General Electric Co. (GE) led a 27 percent rise in corporate bond sales.

The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, declined 3.9 basis points in the week to a mid-price of 95.2 basis points, according to prices compiled by Bloomberg.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed 1.5 basis points to 128 at 9:55 a.m. in London. In the Asia-Pacific region, the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan rose 1 to 130.

First Sale

The indexes typically fall as investor confidence improves and rise as it deteriorates. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

GE, the biggest maker of power-generation equipment, issued $7 billion of bonds in its first offering in almost five years through the Fairfield, Connecticut-based parent company, according to data compiled by Bloomberg. Hospital chain Tenet Healthcare Corp. (THC) sold $800 million of high-yield bonds as part of a four-point plan that includes share buybacks.

Telefonica SA (TEF), Spain's biggest phone company, and Italy's Mediobanca SpA tapped European bond markets amid renewed investor appetite for securities from the continent's most indebted countries.

Corporate bond yields tumbled to a record, with the Bank of America Merrill Lynch U.S. Corporate & High Yield Master index dropping to 3.676 percent before paring its decline to end the week at 3.7 percent.

Labor Department figures on Oct. 5 showed the U.S. unemployment rate fell to 7.8 percent in September, the lowest since President Barack Obama took office and down from 8.1 percent in August.

The U.S. two-year interest-rate swap spread, a measure of debt-market stress, rose for a third week, increasing 0.31 basis point to 13.69 basis points. The gauge, which reached a 2 1/2-year low of 12.31 on Sept. 14, widens when investors seek the perceived safety of government securities and tightens when they favor assets such as company debentures.

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Libor Being Set by Fewer Banks

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