The financial sector must prepare to move to a different, more reliable way of building interest rate benchmarks, the UK's FCA says.
The chief of the UK’s Financial Conduct Authority says banks and other players in markets must prepare for when the London Interbank Offered Rate, or LIBOR, ceases to be used as a benchmark reference rate and is replaced, as soon as the end of 2021. LIBOR has been the centre of rate-rigging scandals in recent years, triggering a mass of fines on banks in a number of jurisdictions.
Andrew Bailey, chief executive of the FCA, said in a speech that LIBOR, which is composed by financial participants submitting prices for inter-bank interest rates, has benefited from improvements as a result of regulations imposed on the system by the FCA since April 2013. However, there remain concerns whether all benchmarks give an accurate picture, such as in cases of insufficient underlying trading and liquidity.
In June, the watchdog sought to gather market figures from 49 banks to ensure data is up to date. Based on evidence so far, activity in some markets is limited and there is little prospect of that changing soon, Bailey said. “Moreover, panel banks feel understandable discomfort about providing submissions based on judgements with so little actual borrowing activity against which to validate those judgements,” he said.
The reason that LIBOR’s integrity and usefulness matters is because the benchmark has become a “public good”, to use Bailey’s own term. LIBOR is used as a reference point for mortgages, savings and investments products.
Shortly after the 2008 financial crisis erupted, stories emerged of banks and other players fiddling the LIBOR system by submitting inaccurate data to manipulate LIBOR rates for commercial gain. A number of banks were fined. Bob Diamond, CEO of Barclays, one of the first banks at fault, resigned. Regulators have been worried that problems in the system have weakened confidence in London’s standing as a financial centre. Royal Bank of Scotland, UBS, Deutsche Bank, Citigroup and JP Morgan have also been punished for transgressions.
There have been calls for alternatives to the LIBOR system, with the idea of basing interest rates on transactions rather than bankers’ judgements.
“That offers a better model for those whose data are needed to produce the benchmark. Most importantly, it is also a better model for those that rely on the benchmark,” Bailey said.
“We do not think we will complete the journey to transaction-based benchmarks if markets continue to rely on LIBOR in its current form. And while we have given our full support to encouraging panel banks to continue to contribute and maintaining LIBOR over recent years, we do not think markets can rely on LIBOR continuing to be available indefinitely,” he continued.
“Work must therefore begin in earnest on planning transition to alternative reference rates that are based firmly on transactions. Panel bank support for current LIBOR until end-2021 will enable a transition that can be planned and can be executed smoothly. The planning and the transition must now begin,” Bailey added.