Regulators Moving Soon on Principles to Replace Libor

Global regulators plan to complete by the summer the first step in overhauling financial benchmarks after three banks paid more than $2.5 billion in fines to settle interest rate rigging charges.

An International Organization of Securities Commissions task force on financial benchmarks, including the London interbank offered rate, plans to publish a final document on principles for improving oversight of rates in the late spring or summer, Jacqueline Mesa, director of the international affairs office at the U.S. Commodity Futures Trading Commission, said at a roundtable meeting in Washington.

“What we’re collectively looking at is how to enhance the rules around conflicts of interest, governance, submitters, administrators,” CFTC Chairman Gary Gensler told reporters after the meeting at the agency’s Washington headquarters. Gensler said at the meeting that the challenge for regulators after the IOSCO document may still be how to improve rates where there isn’t an underlying market.

The roundtable meeting was part of a task force run by the CFTC and U.K. Financial Services Authority that published an initial consultative paper on benchmark rates on Jan. 11. The group began work after Barclays Plc became the first of three banks, including UBS AG and the Royal Bank of Scotland Group Plc, to pay $2.5 billion in fines for rigging of Libor and other global interest rates. About 20 financial firms are part of the global investigation of rate-rigging.

The IOSCO task force will seek additional public comments before the final document is published, Mesa said.

Viability Questioned

Gensler, who leads the agency that spearheaded the investigation of rate manipulation, has questioned the long-term viability of Libor and other benchmark rates, saying the underlying markets must be based on transactions and not estimates from banks.

“If it’s not anchored, I don’t know what it means truly,” Gensler said at the meeting yesterday. “It’s only through real transactions entered into at arm’s length between buyers and sellers that we can be confident that prices are discovered and set accurately.”

The IOSCO document will probably include more detailed governance standards and best practices for rates that are derived from submissions rather than through equity indexes, Gensler said. The regulatory process is also seeking comment on how to transition to new rates.

Innovation Damping

Participants at the roundtable warned regulators against imposing direct U.S. regulation over all rate-setting organizations. “Too much regulatory oversight could really dampen that innovation,” Julie Winkler, a CME Group Inc. managing director, said at the meeting.

CME Group Inc., the world’s largest futures exchange owner, has the most popular interest-rate future in the Eurodollar, even as trading volume in the first 10 months of 2012 fell 24.7 percent from a year earlier, according to statistics compiled by the Futures Industry Association, an industry trade and lobbying group. The contract tracks interest-rate movements over three months and settles against Libor rates.

Regulators should focus additional regulatory scrutiny on benchmarks that include discretion for rate-setters and don’t rely on liquid and exchange-traded underlying markets, Thomas Callahan, chief executive of NYSE Liffe U.S., said at the meeting.

“Where there is discretion there is greater potential for manipulation,” Callahan said. “Where there is greater potential for manipulation there needs to be greater regulatory oversight up to and perhaps including direct regulatory oversight.”

‘Unnecessarily Limiting’

The Global Financial Markets Association, a trade group representing securities advocacy groups in Europe, the U.S. and Asia, said benchmarks don’t need to be based on actual transaction data. Some markets have little transaction volume and still benefit from having a benchmark, the groups said.

“GFMA believes that it is unnecessarily limiting to mandate that a benchmark be based solely on actual transaction data,” the organization said in a Feb. 11 letter to the task force. “Provided that a sufficiently robust governance and control framework is in place and there is clear transparency, benchmarks determined under a variety of methods can be of great value to users.”

Libor is calculated by a poll carried out daily by Thomson Reuters Corp. on behalf of the British Bankers’ Association, a banking industry lobby group, that asks firms to estimate how much it would cost to borrow from each other for different periods and in different currencies. The top and bottom quartiles of quotes are excluded, and those left are averaged and published for individual currencies before noon in London.

“The idea that pervasive manipulation, or attempted manipulation, is so widespread should make us all query the veracity of the other key marks,” Bart Chilton, one of three Democrats on the five-member commission, said in a statement. “For me, this means every single mark needs to be reviewed, and potentially investigated.”

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