A global borrowing benchmark that became synonymous with rigged financial markets, and cost banks some $9 billion in fines, is going away. Andrew Bailey, the head of Britain’s Financial Conduct Authority, said in a speech today that the regulator will phase out the indicator, Libor, by the end of 2021.
Bailey said the reason the London interbank offered rate is being scrapped is because the market underpinning the benchmark—unsecured bank lending—has dried up. For one particular Libor benchmark—there are many rates for various durations and currencies—there were only 15 transactions last year, he said.
Such benchmarks have long been problematic and susceptible to manipulation. Libor, for example, is based on an estimate of what supposed experts at banks think a borrowing rate would be. Bloomberg describes the process like this:
The benchmark is the average rate a group of 20 banks estimate they’d be able to borrow funds from each other in five different currencies across seven time periods, submitted by a panel of lenders every morning. Its administration was overhauled in the wake of the scandal, with Intercontinental Exchange Inc. taking over from the then-named British Bankers’ Association.
Before the financial crisis, banks submitted daily estimates of borrowing rates to the BBA, which then averaged them to calculate that day’s Libor rate. Via allegedly colluding, the banks submitting rates could nudge the average up or down, depending on what was needed to increase a profit or reduce a loss in their portfolios.
Libor is of global importance because it’s used to help determine borrowing costs for more than $300 trillion in securities, for things like student loans and mortgages. But as a trader once said in a transcript uncovered by regulators, it’s “just amazing how libor fixing can make you that much money.”
The Libor scandal was also part of an era in which recorded electronic communications—chat messages—became evidence and got a lot of people in a lot of trouble. Similar market manipulation was discovered in things like foreign-currency exchange rates and commodity prices.
And now Libor is being scrapped. Banks didn’t really want to participate in the rate-setting process anymore anyway, Bailey said, given the market had shrank by so much. (Their recent history of being fined billions for their role in daily rate submissions probably didn’t help.) Some new indicator will have to be agreed on.
Bailey said regulators are looking to base the new benchmarks on rates observed from actual transactions in actively traded markets. This should reduce the potential for manipulation, but history suggests that it’s unlikely to eliminate it completely.