The U.K. Financial Conduct Authority will phase out LIBOR by the end of 2021 Andrew Bailey, the head of the regulator, said in a speech Thursday. It has become clear there isn't enough meaningful data to sustain the benchmark that underpins more than $350 trillion in securities, he said.
The end of the London interbank offered rate is welcome on many levels for regulators. The key interest-rate indicator was tied to some of the banking industry's biggest scandals, leading to about $9 billion in fines and the conviction of several bankers for manipulating the rate. Relying on the opinions of industry insiders to set the daily estimates based on interbank lending — some in markets that saw fewer than 20 transactions annually — was unacceptable, Mr. Bailey said.
"LIBOR is trying to do too many things: it's trying to be a measure of bank risk and it's trying to substitute for interest-rate risk markets where really it would be better to use a risk-free rate," said Mr. Bailey in an interview before the speech. "It's had to come to a conclusion."
Mr. Bailey said setting a firm schedule will help banks and finance companies manage the transition from LIBOR, which is behind securities including student loans and mortgages.
The benchmark is the average rate a group of 20 banks estimate they'd be able to borrow funds from each other in five different currencies across seven time periods, submitted by a panel of lenders every morning. Its administration was overhauled following the scandal, with Intercontinental Exchange Inc. taking over from the then-named British Bankers' Association with the aim of making the rate more transaction-based.
But Mr. Bailey said the market supporting LIBOR — where banks provide each other with unsecured lending — was no longer "sufficiently active" to determine a reliable rate and alternatives must be found. For one currency and lending period there were only 15 transactions in 2016, he said.
"The absence of active underlying markets raises a serious question about the sustainability of the LIBOR benchmarks," said Mr. Bailey, who is widely seen as a candidate to be the next governor of the Bank of England. "If an active market does not exist, how can even the best run benchmark measure it?"
The search for a new benchmark might lead to tighter swap markets, lower rates and richer attorneys as contracts need to be rewritten and adjusted to remove LIBOR.
"The impact of this decision from the FCA is to put uncertainty into all LIBOR-based swap rates," said Peter Chatwell, head of European rates strategy at Mizuho International in London. "The market will need guidance as to what a replacement could be and this will lead to increased volatility and possibly reduced liquidity in the near term."
The FCA only started regulating LIBOR in 2013, the same year legislation was passed making it a criminal offense to take any misleading action in relation to financial benchmarks.
FCA officials have spoken to the panel banks over recent months about ending the use of LIBOR and how much time it would take to wind down, Mr. Bailey said. While it would be tough, most said it could be done in four or five years, and the FCA has asked banks to continue submitting rates until the end of 2021.
