Fed, Banks Discuss Libor Alternatives

WASHINGTON — The Federal Reserve met with members of the world's largest banks and other global financial regulators on Monday to discuss alternatives to discredited interbank reference rates.

The Fed scheduled a meeting with representatives of fifteen of the world's largest banks — including Citigroup, JP Morgan Chase, Bank of America, Goldman Sachs and Wells Fargo — to "discuss the process for developing risk-free reference rate alternatives" to the London interbank offered rate, or Libor, in financial transactions. Financial regulators and central bank representatives from the European Union, Japan, Switzerland and the U.K., as well as other U.S. regulators, also attended the meeting.

The integrity of Libor was severely undermined in 2012 when allegations surfaced that the reference rate — nominally the average rate of interest for unsecured funds between London banks — had been widely and systematically manipulated for more than 10 years. Libor and other reference rates are baked into a wide variety of financial transactions, including derivative contracts, commercial loans, securities and bonds, and are relied upon for valuation, accounting and credit purposes.

Allegations of manipulation were borne out when U.S. and U.K. regulators fined Barclays, UBS, RBS and Rabobank with billions in cumulative fines for manipulating Libor. Similar allegations of manipulation of other reference rates, including the European interbank offered rate and the Tokyo interbank offered rate, have surfaced as well. In January NYSE Euronext took over administration of Libor.

"Reference rates are one of the foundations of the financial system," Federal Reserve Board Gov. Jerome Powell said in a press release announcing the meeting. "Certainly, it is in the interest of everyone, from the residential mortgage holder to the financial institutions that heavily use these rates, that they have integrity and be well constructed and resistant to manipulation."

Reference rates like Libor are generally used as a barometer of market confidence. But since the financial crisis, the interbank liquidity market has dried up to the point where even if there were no manipulation of the rate, there would be too few transactions upon which to base an objective benchmark.

The Financial Stability Board in July released a roadmap for resolving the reference rates' collapse. The international regulators called for reference rates to be pinned to the extent possible to actual transaction data in the near term — a methodology nicknamed IBOR+. Reports on the feasibility of that methodology are to be prepared by the first quarter of 2015.

In the long term, the FSB is working with regulators and market participants to identify alternative reference rates to replace the market role of Libor. The FSB report suggests that "certain financial transactions, including many derivatives transactions, are better suited to reference rates that are closer to risk-free" while also providing the market with more choice.

The July FSB report calls for market participants to suggest potential alternative rates and administrators by the second quarter of 2015, with overall feasibility and compliance studies to be complete by the third quarter and public consultation to be complete by the first quarter of 2016.

The meeting comes only days after U.S. regulators reached settlements with several major banks — including several attending the Monday meeting — over manipulation of certain foreign exchange rate benchmarks. Criminal investigations of forex fraud by the Fed and Department of Justice are ongoing against JPMorgan and Citi.