Pressing the reset button on Libor

September 27, 2012: 7:01 PM ET
libor fix
Britain's banking regulator outlines recommendations to reform the Libor system after revelations that Barclays manipulated the interest rate benchmark to benefit trades and its own bottom line.
NEW YORK (CNNMoney)

Britain's banking regulator will announce sweeping reforms Friday that will change the way a key lending rate is set and regulated.

Calls for reforming or replacing Libor -- the benchmark rate set in London that's used as a reference for over $300 trillion worth of loans worldwide -- have been growing louder ever since Barclays (BCS) settled charges with U.S. and U.K. regulators over manipulating Libor to benefit its own bottom line.

Following a three-month review, Martin Wheatley, the managing director of Britain's Financial Services Authority, recommended stripping the British Bankers Association of its 26-year-old role of overseeing how Libor rates are set each day.

"The BBA clearly failed to properly oversee the Libor setting process and should take no further role in the administration or governance of Libor," said Wheatley in prepared remarks. "Responsibility should be transferred to a new administrator."

Related: Explaining the Libor interest rate mess

Earlier this week, the BBA said it would support Wheatley's recommendations, including its removal from the process.

Wheatley also recommended streamlining the number of reference points used to set Libor. Currently, rates are set by asking between seven and 18 large banks what interest rate they would have to pay to borrow money across 15 different periods of time and 10 different currencies.

Wheatley's recommendations aim to eliminate some of the maturities and currencies that "lack a sufficient amount of trade data to corroborate submissions." That would reduce the number of Libor reference rates from 150 to about 20, said Wheatley.

"The market also needs to know whether a submission has been made based on transactions or not," he said. That was part of the problem in 2008, when banks were submitting quotes but very little, if any, actual lending was taking place.

Wheatley said the system was fraught with conflicts of interest from the start. "With traders' bonuses dependent on the Libor rate, and no bank wanting to be seen as vulnerable in such a transparent system, too many people had a vested interest in gaming the system," he said.

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In an effort to discourage future manipulation of the rate, Wheatley proposed delaying the publication of individual submissions by at least three months and possibly forcing banks that use Libor but don't help set it to be part of the rate-setting process.

Wheatley also suggested bringing on the FSA as the Libor regulator so that it can supervise the firms and individuals involved in the Libor process and take action against misconduct.

"In hindsight, it now appears untenable for such an important process to be unregulated," Wheatley said.

Related: Libor and the folly of deregulation

He'd also like the FSA to be able to approve the key individuals who are involved in the Libor process, "ensuring that they are fit and proper to perform the job, something which is clearly lacking in the present system."

Wheatley also called for amending the Financial Services and Market Act to classify any manipulation or misrepresentation of Libor as an offense, enabling the FSA to use "criminal powers" against offenders.

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While some of Wheatley's recommendations would take time to implement, others, such as phasing out contributions that lack sufficient data, could be put in place within the next 12 months.

Wheatley also noted that Libor is just one of many important benchmarks, and hopes his review and report on Libor will drive a wider debate on other benchmark rates, and possibly help develop a set of principles that can be applied across all major benchmarks.

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