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Gensler Raises Renewed Doubt Over Libor Benchmark Integrity

U.S. Commodity Futures Trading Commission Chairman Gary Gensler raised fresh doubt about Libor’s integrity as a market benchmark, saying banks’ reported borrowing costs remain distorted.

On 85 percent of occasions in 2012, the 18 firms that contribute to dollar Libor left the rate at which they said they could borrow in the interbank market unchanged, even as the cost of insuring their debt against default using credit-default swaps soared, Gensler, 55, said in a speech at the City Week conference in London today.

“This was during a period when there were a number of uncertainties in the market driven by elections, changing economic outlook and other events,” Gensler said. “And yet somehow these banks said they could still borrow at exactly the same rate for four to five months.”

Gensler is among global regulators leading a push to base market benchmarks such as the London interbank offered rate on data from actual trades after an investigation by U.S. and U.K. regulators uncovered widespread attempts by banks to rig Libor for profit. Royal Bank of Scotland Group Plc, UBS AG, and Barclays Plc have been fined more than $2.5 billion and at least a dozen more firms are still under investigation.

“Libor, Euribor and other similar interest-rate benchmarks are unsustainable in the long run,” Gensler said. “These benchmarks, referencing markets with insufficient transactions, particularly in longer tenors, undermine market integrity and threaten financial stability.”

Long-Run Instability

Libor is calculated daily through a survey in London that asks firms how much it costs them to borrow cash from each other for various durations in different currencies. The top and bottom quartiles of quotes are excluded, and those left are averaged and published for individual currencies in London. Because benchmarks such as Libor and its European counterpart Euribor are based on estimates, rather than actual trade data, they are vulnerable to manipulation by traders.

The financial crisis of 2008 all but froze the interbank market, and the latest round of Basel rules on bank capital may discourage firms further from lending to one another in the interbank market, Gensler said. That may worsen the scarcity of actual transactions on which to base Libor, he said.

“Continuing to support Libor and Euribor in the name of stability may have the opposite effect,” he said. “Using benchmarks that threaten market integrity may create more instability in the long run.”

‘Too Big to Replace’

Alternatives include the overnight swaps rate and short-term collateralized financing rates such as general collateral repo rates, he said. Replacement rates could run in parallel with their predecessors for a period -- before the obsolete benchmark is discontinued at a set date, he said.

“We must move forward in a coordinated global effort to identify alternative interest rate benchmarks anchored in observable transactions and plan a smooth and orderly transition from benchmarks referencing unsecured, interbank markets,” he said. “It’s best that we not fall prey to accepting that Libor or any benchmark is ‘too big to replace.’”

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