[LONDON] The Bank of England will spell out next year how markets can migrate to a new "risk-free"interest rate benchmark after banks were fined billions of dollars for trying to rig Libor, the existing benchmark, a senior BoE official said on Wednesday.
Chris Salmon, the BoE's executive director for markets, said Libor, or the London Interbank Offered Rate, a benchmark for interest rates that banks charge each other, remains too prevalent.
Formerly overseen by the British Bankers' Association (BBA), Libor rates have come under scrutiny after a number of traders were accused of colluding to rig the rate. The rates are calculated through an "honor system" in which a panel of banks report their estimated costs of borrowing from each other in different currencies over differing periods.
In the first trial of a defendant accused of Libor rigging, a former trader for UBS, Tom Hayes, was convicted in August 2015 and sentenced to 14 years in jail.
Some 250 billion pounds (US$382.50 billion) of corporate loans reference sterling Libor and it is still the key interest rate in sterling derivatives markets, where it is a reference for contracts with a notional value of about 25 trillion pounds. "Yet in many of these contracts, users are looking to hedge the general level of interest rates, for which a near-risk free rate would be a more appropriate reference rate than Libor, which contains a bank credit risk component," Salmon told an Association of Corporate Treasurers conference.
The BoE has been working for the past year on an alternative near risk-free reference rate, he said. "The aim of this work is to transition a significant portion of new derivatives contracts to the alternative reference rate, moving to a world where Libor is used when it is appropriate to account for bank credit risk, but not otherwise," Salmon said. "The working group has made good progress and I expect that a concrete timetable for making a reality of this change should become clear during the course of next year." Corporate treasurers will have to decide whether and how to adapt their use of reference rates once this transition is underway, he said.
Echoing speeches from two BoE deputy governors over the past week, Salmon cautioned that companies who want to raise money on fixed income markets may find it harder given increased volatility.
There was no "free lunch" for companies who shift from banks to bond markets for raising funds as the latter can be fickle as well. "The risk is that this volatility could make it more difficult for corporates to issue new debt," Salmon said. "Issuers have to ensure that they understand the risks, as well as the benefits, of increased usage of market-based finance - not least those new issuers that have only experienced exceptionally supportive conditions." REUTERS