UPDATE 1-Global watchdog recommends multi-pronged reform of Libor benchmarks

Tue Jul 22, 2014 11:10am EDT

(Adds more detail, background)

By Huw Jones

LONDON, July 22 (Reuters) - Global regulators have proposed a twin-track approach to ensuring that interest rate benchmarks are less prone to manipulation by recommending safeguards to the current system and also by developing alternatives.

Ten banks and brokerages have paid around $6 billion to date to settle U.S. and European regulatory allegations that they manipulated the London Interbank Offered Rate, or Libor, a benchmark against which around $450 trillion of financial products from derivatives to home loans are priced worldwide.

The Financial Stability Board (FSB), which coordinates financial regulation for the Group of 20 economies (G20), has looked at how Libor could be made less prone to rigging, such as by basing the benchmark as much as possible on actual market transactions.

Libor is currently based on banks quoting rates at which they think they could borrow from another bank.

The FSB, which has been working on the plans since last year, has agreed with market practitioners - mainly banks and brokerages - on a so-called "multiple-rate approach" to reforming Libor over the coming two years.

This will involve strengthening Libor and its continental European counterpart Euribor by underpinning them with market transactions data, the FSB said.

Administrators of the benchmarks have until the end of next year to consult on any changes to the current system.

Alongside this, the regulator said work should also start on developing a Libor alternative, such as so-called "nearly risk free reference rates," which would be entirely based on verifiable market transactions.

The FSB wants at least one risk-free rate by the second quarter of 2016.

"Developing such alternative reference rates meets the principle of encouraging market choice," the FSB said.

There had been disagreement among regulators over how to reform Libor. One U.S. agency, the Commodity Futures Trading Commission (CFTC), wanted to scrap it and replace it with a new, market-transactions based benchmark.

But other regulators, including Martin Wheatley, chief executive of Britain's Financial Conduct Authority and who co-headed the FSB's task-force on benchmarks, has been more cautious, saying such a sweeping change carried risks.

Some financial products based on Libor, Euribor and others in the same family stretch out many years, making a quick change legally tricky.

The FSB expects there will be differences in how countries will implement the twin-track approach to reform. It said there were several reasons for this, including differing availability of underlying transactions data and different markets for near-risk-free rates. The FSB also said there were different levels of willingness to use supervisory or other means to encourage market participants to adapt to a multiple-rate approach. (Reporting by Huw Jones, editing by Matt Scuffham and Jane Merriman)