Financial Conduct Authority (FCA) head Andrew Bailey urges industry to solve the “big unanswered question” on Libor
The top City watchdog today put another nail in the coffin of Libor’s use as the go-to “risk-free” rate of lending, urging the industry to look into new ways of solving the problem of legacy contracts.
Andrew Bailey, the head of the Financial Conduct Authority (FCA), said the shift away from London Interbank Offered Rate (Libor) as the main benchmark for lending will “lead to a stronger financial system”, but added that the problem of contracts still tied to Libor leaves a “very big question unanswered”.
In a speech at the London office of the Royal Bank of Scotland, Bailey told the industry to look into solutions such as a “synthetic” version of Libor to serve as a “proxy” beyond the July 2021.
Read more: Financial watchdog says banks will back Libor until 2021
Such a stopgap synthetic Libor could involve the new risk-free rate – expected to be Sonia (the Sterling Overnight Interbank Average rate) for sterling contracts – plus an extra fixed amount to move the new synthetic rate in line with the old Libor measure.
Libor rates is currently used to underpin hundreds of trillions of contracts throughout the world in multiple currencies and over different time periods. For years it was set through a panel of banks offering their best guess of the appropriate rate, until a massive scandal which rocked the City when banks were revealed to have fixed their submissions.
Libor is now administered by Intercontinental Exchange, who insist they will continue to run the benchmark based on real transactions rather than subjective guesses.
Read more: It’s official: The BoE will start setting Libor replacement Sonia in April
It could have a future as a measure of the rate at which banks lend to each other, although it will no longer have the FCA standing behind it.
However, Bailey said Libor was “never an ideal reference rate” for many users because of its exposure to the creditworthiness of banks.
Bailey said: “Borrowers should have better access to variable rates that do not make them carry the risk that their interest payments will go up because confidence in their banks has fallen.”
Meanwhile, addressing recent market volatility, Bailey said regulators need to be on “high alert” because of signs investors are “accepting lower compensation for risk”.
Read more: The likely replacement for Libor may be just as prone to abuse