The U.K. bankers and regulators charged with reviewing Libor in the wake of regulatory probes are resisting calls to overhaul the rate because structural changes risk invalidating trillions of dollars of contracts.
The group, established by the British Bankers' Association in March after probes into allegations that traders rigged the London interbank offered rate, may propose a code of conduct for banks and impose greater scrutiny of Libor's correlation with other financial data over time, according to three people with knowledge of the discussions who asked not to be identified because the talks are private. It won't propose structural changes such as basing the rate on actual trades or taking away oversight of the benchmark from the BBA, the people said.
Libor is determined by a daily poll that asks banks to estimate how much it would cost them to borrow from each other for different timeframes and in different currencies. Because banks' submissions aren't based on real trades, academics and lawyers say they are open to manipulation by traders. At least a dozen firms are being probed by regulators worldwide for colluding to rig the rate, the benchmark for $350 trillion of securities.
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"I don't see a significant enhancement to the reputation of Libor without basing it on actual transactions," said Rosa Abrantes-Metz, an economist with Global Economics Group, a New York-based consultancy, an associate professor with New York University's Stern School of Business and the co-author of a 2008 paper entitled "Libor Manipulation?"
"It would only be disruptive if current quotes are inaccurate," so resistance "is suspicious," she said.
A move to a benchmark based on actual transactions could be gradual, and a change shouldn't result in major disruption as long as banks' submissions reflected their true borrowing costs, she said.
Some on the committee are arguing that the mechanism for setting Libor remains sound and any cases of wrongdoing were isolated, one of the people said. There is broad agreement that any changes to the rate be incremental, the people said. The panel is still to reach its final decisions.
Any substantial changes could affect existing contracts that reference Libor, according to Simon Gleeson, a partner at law firm Clifford Chance LLP in London. Libor is used in financial agreements ranging from mortgages and student loans to swaps.
"There's a tail of contracts that may take 10, 20, 50 years to run off which use Libor as an undefined term, because nobody felt it needed defining," Gleeson said. "The more changes you make, the more likely it is that somebody will be able to argue this is a material change to their contract."
'Lingering Change'
The BBA, which has overseen Libor for 26 years, is under pressure to restore credibility to the rate after regulators from Canada to Japan began probing whether traders colluded to influence the rate to profit from bets on derivatives.
"When the groups involved have reached conclusions about their proposals to ensure that Libor continues to evolve to meet the demands of changing markets, they will make full statements and invite comments from all market participants," the BBA said in an e-mailed statement. "There will be a full consultation with regulators, users and others."
The BBA set up the steering group in March and said representatives from banks, exchanges, the U.K. Financial Services Authority and the British government would serve on it. They have met monthly and plan to publish recommendations within the next two months, two of the people said.
"Keeping things as they are would leave a lingering cloud over the benchmark," said Daniel Sheard, chief investment officer of GAM U.K. Ltd., an asset manager that oversees about $60 billion. "I am yet to hear a valid argument for why it can't be based on actual trades. Given the huge number of transactions that use Libor as a reference, it is very important to re-establish credibility."
Barclays Plc, Credit Suisse Group AG, HSBC Holdings Plc, Lloyds Banking Group Plc and Royal Bank of Scotland Plc are among the firms with representatives in the group. All of the lenders are being investigated as part of probes into Libor. Officials for the banks declined to comment. The firms have said in filings they are co-operating with regulators.
Matt Pollard, a spokesman at the U.K. Treasury, declined to comment, as did Kirsty Clay, a spokeswoman for the Financial Services Authority.
'Index Manipulation'
"Despite its importance, susceptibility to influence, and the allegations of manipulation, Libor remains essentially unregulated," Andrew Varstein, a lecturer at Yale Law School, and Gabriel Rauterberg, an attorney at New York law firm Cooley LLP, said in a paper published in April. "The effects of index manipulation could be vast."
Libor is derived from a survey of London banks conducted each day by Thomson Reuters Corp. on behalf of the BBA. Bloomberg LP, the parent of Bloomberg News, competes with Thomson Reuters in selling financial and legal information and trading systems.
Lenders are asked how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies including dollars, euros, yen and Swiss francs. After a set number of quotes are excluded, those remaining are averaged and published for each currency by the BBA before noon.
Three-month dollar Libor was unchanged at 0.461 percent today. The comparable rate in euros slipped to 0.556 percent.
"Regardless of who is to blame or whether manipulation went on, all the ingredients are there for it," said NYU's Abrantes-Metz. As well as basing the rate on actual trades, she suggested increasing the number of banks that are surveyed and making the submissions anonymous. Individual banks' submissions are at present published daily.
One option would be for the BBA to create a new benchmark for contracts in the future and continue to publish Libor using the existing method while outstanding contracts wind down, Gleeson and Abrantes-Metz said.
It's the third time the BBA has revisited Libor in four years. In December 2008, it created two new sub-committees to oversee the rate amid concern that some banks lowballed their borrowing costs to avoid the perception they were struggling in the wake of Lehman Brothers Holdings Inc.'s failure. Lenders were also asked to justify any discrepancies between their submissions and those of their competitors. In February 2011 it increased the number of banks on the dollar Libor panel to 20 from 16.
'Cosmetic Changes'
Those changes failed to stem suggestions that the rate was vulnerable to abuse. At least nine regulators in the U.S. Canada, Europe and Asia are looking into whether traders colluded to rig Libor.
Traders interviewed by Bloomberg in March at three firms said they were given no guidance on how Libor should be set and there were no so-called Chinese walls preventing contact between the treasury staff charged with submitting the rate and traders who stood to profit on where Libor was set each day. They regularly discussed where Libor would be set with their colleagues and their counterparts at other firms, they said.
"Sadly the response looks to be very consistent with the response of policy makers to the banking disasters we've seen over the last four years — cosmetic changes, but nothing substantial happens," said Richard Werner, a finance professor at the University of Southampton. "It's insufficient and doesn't really go to the heart of the problem."
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