Global regulators set out plans to overhaul the way key financial benchmarks are calculated as they try to re-establish confidence in key market rates tarnished by manipulation scandals.

The Financial Stability Board said rates, particularly those such as Libor used to calculate interest rates, should be “to the greatest extent possible” based on actual trade data rather than employees’ estimates, according to a statement published on its website today. The FSB, which consists of regulators and central bankers from around the world, also called for the development of alternative benchmarks.

The regulators are acting after traders at some of the world’s biggest firms manipulated the London interbank offered rate by lying about their firms’ true borrowing costs or colluding with colleagues at other firms to rig the benchmark for profit. They were able to succeed because the benchmark was based on guesswork about the cost of money rather than actual transactions between banks.

“The FSB has essentially decided that the U.K. can’t fix rates because no one country or its financial institutions can be relied upon to do so,” Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc., said. “The more transparent, multi-currency approach it has settled on will make financial markets more transparent, but come at the cost of reduced cross-border liquidity that will speed the fragmentation of global finance back to sovereign markets.”

Benchmark rates “should minimize the opportunities for market manipulation,” the FSB said. They “should be anchored in observable transactions wherever feasible.”

The FSB said it may be better for some trades, including many derivatives, to be tied to the risk-free rate of borrowing rather than unsecured bank borrowing rates. Those alternatives could include the overnight indexed swap rate, government bond rates or compounded overnight interest rates, the FSB said.

“Shifting a material proportion of derivative transactions to a risk-free rate would reduce the incentive to manipulate rates that include bank credit risk and would reduce the risks to bank safety and soundness and to overall financial stability,” the FSB said.


Dollar Swaps

Overnight indexed swaps are over-the-counter traded derivatives in which one party agrees to pay a fixed rate in exchange for the average of a floating central-bank rate over the life of the swap. For dollar swaps, the floating rate is the daily effective federal funds rate, for euros the euro overnight interbank average rate, and for pounds the sterling overnight interbank average rate.

Benchmark administrators should consult on changes to calculations by the end of next year, while regulators should aim to shift derivatives contracts over to the risk-free rates by the first half of 2016.

Administrators for Libor, Euribor and Tibor have “made good progress in implementing the principles related to governance, reflecting the primary focus of the reform process to date,” the International Organization of Securities Commissions, said in its report. Still, “further work is still needed on benchmarks’ methodology and design,” and more needs to be done to manage “conflicts of interests” in the setting of Libor and Tibor, Iosco said.

Libor is calculated by a daily poll that asks firms to estimate how much it would cost to borrow from each other for different periods and in different currencies. At least nine firms, including Barclays Plc and Royal Bank of Scotland Group Plc have been fined more than $6 billion for manipulating benchmark interest rates.

The FSB, which reports to the Group of 20 nations, set up a task force last year to try to overhaul the way benchmarks are calculated and governed.


Bloomberg News