City watchdog tells banks to speed up transition away from Libor to protect financial stability

 
Jasper Jolly
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Libor is currently relied upon by banks and businesses for trillions of pounds of contracts (Source: Getty)

Banks need to speed up their move away from the Libor rate to benchmark trillions of pounds of contracts to avoid risking the stability of the global financial system, the City’s top watchdog said today.

Financial Conduct Authority (FCA) boss Andrew Bailey said that the “pace of that transition is not yet fast enough” and that there was “much further to go”, in a speech today in London.

He also warned that firms will be forced to demonstrate to the FCA that they have plans to “reduce dependencies” on Libor.

Regulators around the world are currently in the process of establishing new “risk-free” benchmark rates to replace the various versions of the London Interbank Offered Rate (Libor) across the world’s biggest currencies. Libor’s reputation was seriously damaged by the string of rate-fixing scandals in the past decade.

Read more: The path to a post-Libor City: BoE takes control of substitute rate Sonia

The Financial Stability Board, the Basel-based central banking body chaired by Bank of England governor Mark Carney, today said that transitioning away from Libor “will enhance financial stability”, in a separate statement urging firms to transition to overnight risk-free rates, which are perceived to be more robust.

There has been “too much complacency” among firms that contracts based on Libor would continue to be valid if it disappeared, Bailey said. Fallback “seat belts” can be added to contracts to ensure they do not become void if a “crash” occurs and Libor stops, but should not be relied upon in place of moving to new rates, he added.

US financial infrastructure giant Intercontinental Exchange has committed to continue to run the Libor rates, but Bailey warned that the end of Libor is not a “remote probability ‘black swan’ event” and that “misplaced confidence in Libor’s survival” could threaten financial stability.

Read more: Serious Fraud Office ends Lloyds Libor probes

He said: “Firms should treat it is as something that will happen and which they must be prepared for.”

However, Timothy Bowler, president of Ice Benchmark Administration, stood by Libor.

He said: “Ice Benchmark Administration fully supports the development of alternative risk free interest rates and increasing choice to the market but we also believe that a reformed Libor could continue to exist alongside these new rates, to serve a different set of customer requirements.”

Bailey pointed to a number of issues with Libor as it is currently constituted, based on lending between banks, including the fact that the rate partly reflects bank credit risk rather than acting as a pure “risk-free” rate.

Meanwhile, the rate does not in many instances rely on actual market transactions, given low liquidity in some currencies over certain time-frames, instead relaying on experts’ judgement. “LIBOR has to be representative,” Bailey said. “I struggle to see the case for this judgement.”

The Sterling Overnight Index Average (Sonia) now being pushed by the Bank of England is now based on an average of 370 transactions per day, compared to Libor’s average of two during the last six months.

Read more: Moody's warns bondholders on uncertainty surrounding Libor phase-out

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