LIBOR review "to consider alternative rate-setting processes", Wheatley says

Martin Wheatley, chief-executive designate of the future Financial Conduct Authority, was speaking to Bloomberg ahead of the publication of a discussion paper (63-page / 800KB PDF) for four-week industry consultation. He said that the review would consider "alternative benchmarks for at least some of the types of transaction that currently rely on LIBOR", regardless of whatever improvements were ultimately proposed for the rate.

However, he warned that any shift to a new benchmark would require "a carefully planned and managed transition", in order to limit disruption to the huge volume of contracts and transactions that currently reference the rate.

He added that if regulators "chose the path of maintaining LIBOR as a reference rate", they must look at the governance and regulation of the rate as well as how it is compiled. Changes to the way the rate is set could include using "transaction-based data" rather than relying on submissions by banks, delaying publication of the daily rate to minimise the risk of manipulation or even altering the calculation itself.

LIBOR is a daily reference rate based on the interest rates at which banks can borrow unsecured funds from other banks. It is widely used as the pricing basis for some $550 trillion worth of global financial instruments including interest rates and currency hedging instruments, and to set the interest rate for syndicated loans. Contributing banks submit estimated rates daily to business data provider Thomson Reuters, which carries out the calculation and publishes LIBOR rates in 10 currencies at midday every London business day.

Wheatley's review was prompted when, at the end of June, Barclays became the first bank to announce that it had entered into settlement agreements with regulators in the UK and US for "misconduct" in relation to its contribution to the LIBOR rate and to its euro equivalent, EURIBOR, for £290 million. However the discussion paper makes it clear that Barclays is "only the first of a number of investigations the [Financial Services Authority] is carrying out into contributing banks".

In his speech, Wheatley said that "the use of actual money market transaction data" as the basis for the rate, as proposed in some areas of the sector following the Barclays announcement, was not without merit.

"People are right to think that such a change could help to overcome the issues of subjectivity and corroboration, and other benchmark rates are structured in this way," he said. "But there are of course still difficulties, not least of which is the low volume of transactions in particular currencies and tenors under the current LIBOR definition of interbank lending. Then there are the governance issues that other benchmarks with this type of construction will still present."

The discussion paper looks at the use of actual transaction data, he said, perhaps coupled with "a widened definition of relevant funding to include other products such as commercial paper or corporate deposits".

"Perhaps some sort of hybrid transaction data and a hypothetical rate might prove most effective, using judgement to fill the gaps where and when data is scarce, within a specified framework," he added.

The paper also seeks views on changes to the rate-setting governance framework, for example by giving responsibility for providing reference rate information to the markets to an independent commercial body rather than the British Bankers' Association (BBA), which currently sponsors the rate. It also considers whether LIBOR-related activities should be formally regulated, or whether the power to prosecute for LIBOR-related offences should be extended to regulators.

Participation in the setting of the LIBOR rate is not currently a 'regulated activity' under the Financial Service and Markets Act, and the FSA is currently unable to pursue criminal sanctions in relation to LIBOR due to the nature of its powers. However the Serious Fraud Office (SFO), the Government department responsible for investigating and prosecuting serious and complex fraud, is currently investigating the alleged manipulation of LIBOR by "a number of financial institutions" under existing fraud and false accounting laws.

The short consultation period is to ensure that any necessary amendments to the law can be included in the draft Financial Services Bill. The Bill, which is currently going through Parliament, will overhaul the current system of financial services regulation in the UK and establish the FCA, as well as a Prudential Regulation Authority (PRA) within the Bank of England to regulate banks, building societies and insurers.

"The discussion paper demonstrates that we will give regulators the powers they need to prevent the manipulation of key benchmark rates in the future," Mark Hoban, Financial Secretary to the Treasury, said. "This review will report by the end of the summer in time for any necessary changes to be taken forward in legislation. The Government is also working with its international partners to inform the international work in this area and work towards a globally consistent solution."

Last month the European Commission proposed the introduction of the specific criminal offence of actual or attempted manipulation of benchmarks, including LIBOR and EURIBOR, as part of its proposals for new laws on insider dealing and market manipulation.