Possible replacement of Libor benchmark

LONDON - The scandal-plagued Libor benchmark is likely to be replaced by a dual-track system with survey-based lending rates running alongside transaction-linked indices as soon as next year.

Martin Wheatley, the UK regulator leading efforts to reform the London Interbank Offered Rate, told the Financial Times that a parallel system would provide continuity for holders of $350tn in existing contracts that reference Libor while also paving the way for a new benchmark tied more closely to objective data.
But the idea could set up a conflict with US regulators, who recently called for a “prompt” switch to transaction-based rates. Gary Gensler, chairman of the US Commodity Futures Trading Commission, which spearheaded the Libor probe, told the FT that the existing system was “unsustainable” in the long run because banks were not doing enough unsecured lending to make accurate estimates.
Global regulatory authorities want to move quickly to restore faith in interest rate benchmarks following the rate-manipulation scandal that has seen three banks pay more than $2.5bn in penalties on three continents with half a dozen other institutions facing fines.
Mr Wheatley, chief executive of the Financial Conduct Authority, said he believes market participants rather than regulators should make the final decision on how and when to scrap Libor.
“You can’t just say: ‘Forget about yesterday’s problems, we’ll just move to the future,’” he said. “If you change the definition, it’s almost certain that one side of every one of those trades would lose out and then would say: ‘We’re no longer bound by this.’”
However, Mr Gensler said: “When a rate becomes obsolete, it is necessary to discontinue it. All of the successful [benchmark] transitions have a date established when the thing no longer exists.”
A UK committee charged with selecting a new Libor administrator is looking for a group that would be comfortable running rates based on estimates and qualified to design and administer a transaction-based replacement, he said. Short-listed candidates are to be interviewed next month.
“You really want an organisation that can run both the old model and the new model together,” Mr Wheatley said. “It may not be possible to design a continuous rate.”
Banks’ Libor submissions, particularly for three, six and 12-month lending, are extremely stable, in part because there are so few transactions that would justify a change. Transaction-based rates, such as the overnight index swap rate, by contrast move up and down constantly.
“From a pragmatic point of view, a two-rate system makes quite a lot of sense because it avoids the dislocating effect of a big bang approach,” said Kevin Milne, chief executive of Rate Validation Services, a benchmark provider.
While many benchmarks have been phased out over a relatively short period, there are precedents for long-lasting parallel runs. More than a decade after the creation of the eurozone shifted interbank lending from pesetas to euros, the Bank of Spain continues to publish a Madrid-based rate (Mibor) as a benchmark for Spanish floating rate mortgages issued before 2000.
(The Financial Times)

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