Banks who submit quotes for compiling Libor interest rates will have to follow a manual of instructions to avoid a repeat of the rigging seen in the past, the benchmark's new administrator said on Monday. Ten banks and brokerages have paid more than $6 billion to settle allegations of rigging the London Interbank Offered Rate or Libor, which is used to price $350 trillion of financial products globally, from credit cards to home loans.
The banks were accused of manipulating the quotes to make themselves look healthier or make more money on derivatives linked to Libor. ICE Benchmark Administration, a unit of Intercontinental Exchange, has been running Libor since taking over from BBA Libor in February following sweeping reforms rushed in by regulators to help restore trust in the benchmark lending rate.
IBA president Finbarr Hutcheson said on Monday the planned manual or "methodology" it has published is a significant step towards making Libor more robust by replacing a variety of practices applied by the 20 submitting banks with a common structure. The IBA's position paper sets out a prescriptive sequence of steps or "waterfall" banks must follow. The paper is being put out to public consultation and a more refined document will come out early next year, with the changes formally introduced from later in 2015. The basic aim of the manual is to ensure that quotes are based on market transactions wherever possible.
But if there are insufficient transactions submitters can "interpolate" or form a quote based on a list of approved alternative transactions. Britain's Financial Conduct Authority has already listed such eligible transactions and the IBA proposes three more - unsecured wholesale funding deposits, commercial paper and primary issuance Certificates of Deposits.
A wider range would reduce the room for judgement even further, the IBA paper says. The manual sets parameters on using judgement "as a last resort" when markets freeze as they did when Lehman Brothers went bust in September 2008. Regulators say Libor must be "anchored" in real market transactions to the greatest extent possible and each Libor rate compiled under the new methodology will indicate the extent to which transactions, interpolation and judgement have been used.
The information will help IBA determine next year if there are enough market transactions in normal times to sustain all 35 Libor rates published daily. Regulators and central banks, such as the Bank of England, the New York Federal Reserve and the Swiss central bank have already been consulted about the IBA's plans. However, the manual won't satisfy US critics of Libor who want it scrapped and replaced with an index based purely on market transactions.
Some users of Libor may also claim "legal frustration" or argue that the IBA's methodology creates a new benchmark so that current contracts based on Libor are no longer valid. After the fines some submitter banks have paid, IBA hopes that by introducing strict, common rules it will "derisk" Libor submissions to encourage existing contributor banks to stay and persuade new ones to join. "We can evisage an approach under which perhaps 50 banks would contribute their transactions on a daily basis," the IBA paper said.