Setting the new LIBOR rate

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Storm clouds are seen above the Canary Wharf financial district in London. Photo – Greg Bos/Reuters

Ever since the LIBOR manipulation scandal came to the foray, there were two main concerns that were raised which had to be considered in the aftermath. The first one was how deep rooted the scandal was and how much it damaged the system retrospectively. The benefits and profits enjoyed by the traders and their respective punishments had to be ascertained. The second one was about market sustainability and how the system would work in the future.

London Interbank Offered Rate (LIBOR) is one of the key fundamentals upon which the world of finance is created. LIBOR is used for indexing from simple borrowing and lending to creation of more complex derivative and financial products. Now that the rate was going to be put under scrutiny, its legitimacy came under fire. The long run credibility of the rate was to be vetted and an alternative must to be decided upon.

One of the first solutions is to set guidelines so that any future manipulation can be avoided. UK Chancellor of Exchequer, George Osborne, has proposed the use of actual trade rates based on the actual market data rather than what the banks quote or report. The Financial Services Authority (FSA) has already proposed amendments to the legislation that is under debate in the Parliament. There is a sense of urgency when it comes to creation of a new system for LIBOR as the world of finance is hinged on the rate. The fallout of the scandal has already seen Barclays being fined $455 million for fixing the rate and in addition, Royal Bank of Scotland, UBS and Deutsche Bank are being investigated as well.

The challenge now for regulators is to first find a new rate which cannot be manipulated easily and is based on more credible information. The second challenge is to make the transformation to the new rate as smooth as possible as many of the contracts that are being traded in the markets are already indexed on the old LIBOR mechanism and any change might give arbitrage opportunities which should be avoided.

The need of the hour is to establish a new structure from scratch which defines new governance rules and also gives clear cut punishments to the participants to deter them. The carrot and stick approach will not only highlight the outlines of the system and what is expected of the actors involved. It also gives the basic punishments for when the actor tries to break the rules of the system for his own advantage.

London has long been considered the financial capital of the world where much of Europe and US comes to trade. With FTSE being one of the key stock exchanges in the world, London has always been seen as a financial hub and centre of most of the financial activity of the world. This scandal, however, will put that claim in danger. The fact that LIBOR, which is set in London, was used to manipulate by the British banks, coupled with financial taxes that have been in the wings for the London market and the HSBC money laundering scandal, it is going to be a dark cloud that will hover over the financial skies for a while. There are talks of a benchmark based crude oil which will take away the monopoly that London has enjoyed over financial transactions.

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