July 22, 2014 / 5:05 PM / in 3 years

UPDATE 2-G20 watchdog orders Libor alternatives by 2016 in benchmark reform

* Libor to be based on transactions as much as possible

* “Risk-free” benchmark needed for derivatives by 2016 (Adds detail)

By Huw Jones

LONDON, July 22 (Reuters) - Global regulators will implement a twin-track approach to ensuring interest rate benchmarks are less prone to manipulation, recommending safeguards to the current system as well as developing alternatives.

Ten banks and brokerages including Barclays and UBS have paid a total of 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 “to the greatest extent 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 and Japanese rate Tibor - by underpinning them with market transactions data, the FSB said on Tuesday.

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 alternatives, 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.


Alternatives could be based on government bond rates, the overnight indexed swap rate, or compounded overnight interest rates. Shifting a material proportion of derivative transactions to a risk-free rate would reduce the incentive to manipulate rates, the FSB said.

EONIA, or euro overnight index average, an overnight interest rate, was a viable, actively used, nearly risk free and available, the FSB added.

Having a range of benchmarks would better fit the needs of differing market participants and reduce possible systemic risk from relying on just one type of rate, the FSB said.

Yet some participants remain concerned of possible market disruption as a result of the reforms and one expert group - made up of banks - said in a report to the FSB that in most cases, fall-back provisions are not sufficiently robust for a permanent discontinuation of any key “ibor” rate and the transition to any new rates must be coordinated.

Meanwhile the FSB is also seeking to bridge a divide among regulators.

One U.S. agency, the Commodity Futures Trading Commission (CFTC), wanted to scrap Libor and replace it with a market-transactions based benchmark. Others, including Martin Wheatley, chief executive of Britain’s Financial Conduct Authority and who co-headed the FSB’s taskforce on benchmarks, have 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 implement the twin-track approach to reform, for several reasons - including the 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.

Separately, the International Organisation of Securities Commissions (IOSCO) published a review of how the administrators of Libor, Euribor and Tibor - Intercontinental Exchange Inc for instance in the case of Libor - had complied with new standards for the benchmarks that it introduced last year.

IOSCO said none of the three could show that data used was sufficiently accurate and reliable. The administrators must say by the end of 2014 how they will address the failings ahead of more checks next year. (Editing by Jane Merriman and David Holmes)

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