In five years' time Libor should be no more.
On Thursday a top U.K. regulator said it will phase out the London interbank offered rate, a scandal plagued benchmark that is used to set the price of trillions of dollars of loans across the world.
Andrew Bailey, the chief executive of the U.K.'s Financial Conduct Authority, which regulates Libor, said Thursday that work will begin to plan for a transition to alternate benchmarks by the end of 2021. "We don't think markets can rely on Libor continuing to be available indefinitely," he said.
Libor is calculated every working day by polling major banks on their estimated borrowing costs. Its integrity was called into question following a rate-rigging scandal where traders at numerous banks were able to nudge it up or down by submitting false data. Banks were fined billions of dollars and several traders were sent to jail. Over the last five years regulators have tried to find ways to tie Libor submissions to actual trades, as opposed to estimations. But in several cases proved impossible because inter-bank lending has hugely diminished, said Mr. Bailey.
In one case banks setting the Libor rate for one version of the benchmark executed just 15 transactions in that currency and 10 in the whole of 2016, he said. The U.K. regulator has the power to compel banks to submit data to calculate the benchmark. "But we don't think it right to ask, or to require, that panel banks continue to submit expert judgments indefinitely," he said, adding that many banks felt "discomfort" at the current set up. The FCA recently launched an exercise to gather data from 49 banks.
The rate, created in the early 1980s, was previously overseen by a British banking lobby group During the financial crisis it was closely watched as a gauge of a bank's health. The lower other banks charged an institution to borrow, the safer it was deemed to be. The problem: bank lending largely froze up, so the Libor rate was based on guesses and in some cases on deliberately skewed data.
Following the rate-rigging scandal it was stripped of its control of the benchmark. In 2014 IBA, a subsidiary of Intercontinental Exchange, became the new administrator of Libor. The IBA implemented a series of changes--including instating a surveillance team that evaluates the data coming out of the banks--to ensure that the lenders' submissions are more accurate. A spokeswoman for the IBA declined to comment.
A group within the Bank of England is working on potential replacements to Libor. Any shift will have to be phased in slowly.
Some GBP30 trillion ($39.4 trillion) of over the counter derivatives reference the rate, while dollar Libor contracts run to the hundreds of trillions, according to the central bank. One potential replacement is the Sterling Overnight Index Average, which is calculated using banks' overnight funding rates in the sterling unsecured market. This rate is currently being reformed by the Bank of England.
Write to Max Colchester at firstname.lastname@example.org
(END) Dow Jones Newswires
July 27, 2017 05:51 ET (09:51 GMT)