The Libor interest rate benchmark used to price billions of pounds of financial products, which was linked to a series of bank scandals, is to be phased out.
The index will be phased out in 2021 despite a series of reforms put in place to clean up the way the rate is set.
Andrew Bailey, chief executive of the Financial Conduct Authority, made the announcement after admitting banks no longer wanted to participate in setting the rate, which underpins the financial system and is used to price more than $350tn of financial products around the world.
Libor – the London interbank offered rate – was a little-known benchmark until the financial crisis and the subsequent discovery that banks had been manipulating the rate. Their activities led to fines totalling billions of pounds. Several senior bankers lost their jobs as a result of the manipulation, and one trader, Tom Hayes from the Swiss bank UBS, was jailed for 11 years for distorting the index.
The scandal prompted a change in the way the rate was set. Previously it was an estimate of the price a panel of banks would pay to borrow from each other, in a number of currencies and over different time periods. The rate was changed to more accurately reflect the actual price the banks paid.
But Bailey said that not enough activity was taking place for the benchmark rates to be priced under the new format. However, the benchmark is so widely used to price financial products that it would take five years for an alternative to be found.
Libor is used to price loans to companies and also – in some countries – to price mortgages.
The problem, said Bailey, was that the market Libor was trying to measure – the price banks lend to each other – was no longer active in the way it was before the 2008 crisis, when banks funded their business by borrowing from one another.
Bailey said regulators did not “suspect further wrongdoing or have any evidence of such”.
He said: “Over the past years I, and my predecessors and colleagues at the FCA, have spent a lot of time persuading panel banks to continue submitting to Libor. We have been concerned that withdrawal of panel banks would weaken the representativeness and robustness of the rate. And we have been concerned about the risk that if one or more banks leave, other panel banks would want to do the same.
“We could not – and cannot – countenance the market disruption that would be caused by an unexpected and unplanned disappearance of Libor.” He said work must “begin in earnest” on shifting to an alternative benchmark.
To illustrate the problems faced, he said one of the interest rates being set was based on submissions from a panel of banks which only conducted 15 relevant transactions in the whole of 2016.
Bailey said: “If an active market does not exist, how can even the best run benchmark measure it?
The regulator has the power to force banks to make submissions to Libor – but not for the five-year transition period envisaged. So 20 banks have agreed to keep doing so.
One possible solution is Sonia – the sterling overnight index average – which reflects bank and building societies’ overnight funding rates in sterling.
