Editorial Board

The U.K. Is Right to Retire Libor

Markets need a better benchmark.

Good move, Mr. Bailey.

Photographer: Simon Dawson/Bloomberg

The U.K.'s Financial Conduct Authority has announced the end of Libor -- the London interbank offered rate, one of the world's most important interest-rate benchmarks. This is no minor technical adjustment. The change will have far-reaching effects in global financial markets.

It's a good move -- and the timing is right.

Libor is used to set payments on more than $350 trillion in financial contracts: interest-rate derivatives, corporate bonds, mortgage loans and more. But this crucial number was constructed in a way that gradually stopped working as it was meant to, and it fell prey to manipulation.

Since the late 1980s, Libor has been compiled every day in London by polling banks on what it costs them to borrow. But banks no longer do much borrowing of the kind that Libor is meant to track. By 2015, less than a third of submissions for the three-month dollar rate were based on actual transactions. The dearth of real activity left the rate open to the illicit fixing that occurred throughout much of the 2000s, undermining trust in financial markets (and resulting in prison terms for several bankers).

QuickTake What Is Libor and Why It Will Soon Be History: QuickTake Q&A

Markets need a better benchmark, or set of benchmarks, based on observable transactions. In the U.S., the Federal Reserve has been working on this, gathering the data needed to track rates in the so-called Treasury repo market. But as long as Libor exists, getting a better standard adopted faces a sort of Catch-22: Few market participants want to issue bonds or make loans against a new benchmark before an established derivatives market allows for hedging -- but there's little incentive to create such derivatives until enough bonds and loans have been issued.

That's why the FCA's pledge to phase out Libor by 2021 is so valuable. As the benchmark's overseer, it's in a unique position to push financial markets to make the change -- one that will ultimately benefit everyone. There's work to be done to make a success of the transition, but with viable alternatives now in sight, the decision is well-timed.

    --Editors: Mark Whitehouse, Clive Crook.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

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