The City watchdog will on Friday fire the starting shot on a dramatic overhaul of key benchmark borrowing rates with a package of proposals designed to restore trust following the recent Libor scandal.
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Martin Wheatley, who heads conduct regulation for the Financial Services Authorityand has been asked by the government to review Libor , will say the existing structure and governance of the rate is “no longer fit for purpose” and must be fixed.
His suggestions for reform include scrapping Libor altogether and replacing it with a borrowing rate based on actual trades, which could be overseen by a new independent body rather than the British Bankers’ Association.
He also considered introducing criminal sanctions in respect of potential Libor manipulation– although the discussion paper makes clear this would be difficult for the regulator to do.
“The attempted manipulation of Libor and its European equivalent Euribor have cast a shadow over the industry at large and the construction and governance of the benchmark themselves,” he will say in a speech at Bloomberg this morning.
Mr. Wheatley’s proposals are the initial step of an independent review that was ordered by George Osborne, the UK chancellor, after Barclays became the first bank to be fined for attempting to rig Libor.
The scandal cost Barclays290 million pounds ($355.8 million) as well as its chief executive and chairman. Other banks are expected to be penalized later this year.
“It is clear that regardless of the outcome of ongoing international investigations, trust in a vital part of the financial system has been badly damaged and timely action is needed to restore it,” Mr. Wheatley will say.
His review focuses on three key areas – strengthening the current framework for setting and governing Libor; tackling abuse; and assessing whether changes are also required for other price-setting mechanisms such as equity and commodity benchmarks.
Much debate has centered on whether the rate-setting process could be taken out of the banks’ hands – by basing it on actual trades rather than the rates institutions expect to be able to borrow at.
Mr. Wheatley believes this change would help overcome a number of existing issues with Libor, although would be problematic when low volumes of transactions were taking place.
One option would be to use a mixture of actual transaction data and predicted rates. “Perhaps some sort of hybrid of transaction data and a hypothetical rate might prove most effective, using judgment to fill the gaps where and when data is scarce, within a specified framework,” he suggests.
One likely outcome from the review is that rate setting is made subject to more formal regulation. Mr. Wheatley suggests this may mean that individual submitters require special FSA clearance. He also raises the question as to whether banks should be forced to partake in the currently voluntary process – a move that would enlarge the current pool of submitters.
In terms of governance he says a “much greater degree of independence, transparency and accountability” is needed around borrowing rates. The process could be moved away from the BBA, which currently sponsors Libor, to a commercial body or a newly created independent trade body, for example.
There will be a period a discussion until September 7. Mr. Wheatley expects to publish final recommendations for regulatingand improving Libor and similar rates by the end of next month.