How to fix Libor? International regulators seem to have rather different ideas

Future of Finance
Future of Finance
Gary Gensler, chairman of the United States' Commodity Futures Trading Commission (CFTC) delivers a talk on global derivatives regulation at the London School of Economics, in London, Thursday, Oct. 13, 2011. (AP Photo/Lefteris Pitarakis)
US regulator Gary Gensler wants to reform Libor faster. (AP Photo/Lefteris Pitarakis)

International regulators have been working on ways to replace Libor, the world’s most important benchmark financial rate, which was tainted by scandal last year. But they seem to be saying different things about how to do it.

Libor—the London Interbank Offered Rate—is an average of the rates at which banks borrow from each other overnight, and is used as a basis for $379 trillion worth of other financial instruments. The source of the scandal was that Libor is based entirely on the rates that bank traders say their banks are getting rather than actual transactions that take place, and traders turned out to have frequently lied in order to make themselves or their banks look better.

In the United Kingdom, Martin Wheatley, head of the Financial Services Authority, has said that he’s interested in a two-track system (paywall). The existing contracts based on Libor could continue without abrupt change, and new contracts would be based on new rules and more objective data. This, it is hoped, would avoid upsetting the markets.

Wheatley also wants a single organization in charge of managing old and new rates, and proposes reducing the current 150 versions of Libor (for different currencies and borrowing periods) to 20. This would simplify things by getting rid of rates—such as the Libor for borrowing Swedish krona for nine months—that are rarely used as the basis for anything.

In the United States, Gary Gensler, chairman of the US Commodity Futures Trading Commission, appears to disagree with Wheatley. He has championed a “prompt” switch from Libor to a new rate based on actual transaction data. “Continuing to support Libor and Euribor in the name of stability may have the opposite effect,” Gensler said at a conference last month. It seems his proposals would disrupt the current swaps market and put new and old contracts on the same system.

In the euro zone, financial services commissioner Michel Barnier appears to favor less dramatic change change. He told Bloomberg that, though transaction data should be used to calculate whatever replaces the old Libor rate, in the absence of sufficient data, “we should allow the publication of indices based on estimates, as long as a clear methodology is used.” This implies that, unlike Wheatley, he doesn’t want to eliminate the rarer forms of Libor. Moreover, Barnier has advocated regional enforcement of Libor submissions, seemingly at odds with a centralized system to manage rates.

That regulators aren’t on the same page over how to fix Libor is no surprise. We argued back in September that they ‘d have trouble. And this isn’t their only squabble: they’re even more at odds over new rules in the US and the UK that would hinder bank capital from moving freely through the international financial system. The devil is always in the details.

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