UK blazes the right trail on Libor reform

September 28, 2012

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Martin Wheatley’s Libor reforms strike the right balance. Given the tidal wave of public anger in June when Barclays was shown to have attempted to fiddle the critical benchmark interest rate, the UK regulator could have recommended the London Interbank Offered Rate be scrapped entirely. His actual approach – reform rather than revolution – makes more sense.

Wheatley is right to state that Libor’s role underpinning $300 trillion of global financial contracts makes it nigh on impossible to bin right now. But he’s also right that the current system needs a complete overhaul. The fundamental call is whether to stick with the current rate-setting process, using rates that banks say they are borrowing at, or to move to using actual traded data. The latter is preferable as it is less easy to fiddle. But in a market panic there may not be enough data to enable an accurate benchmark.

The report recommends a balance. Banks should keep on submitting rates, but will need to show Libor’s supervisors how these tally with actual market data. To make sure this data is credible, a greater number of banks will report the 20 most-frequently traded maturities and currencies, instead of 150. And to ensure that banks won’t look vulnerable if they submit high rates, the individual submissions made by banks will not be published for three months.

Wheatley is rightly less nuanced on a baffling loophole in the current system that means submitters are not subject to FSA scrutiny. From now on they will be, and the regulator will be able to use criminal powers to deal with attempted manipulation. He has also confirmed that the discredited British Bankers’ Association will no longer oversee the submission process.

Picking a sufficiently credible replacement will be crucial. Libor’s new administrator will need to show much greater independence than the BBA, a bank lobby group, managed. An existing recognised exchange may fit the bill.

Ultimately, Libor’s future will depend on whether market participants still want to use it. Wheatley stresses that other benchmarks may in future be more appropriate. But his proposals provide a decent blueprint over what to do until the market delivers its verdict.

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