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From Securities Regulation Daily, February 28, 2013

CFTC Chairman Gary Gensler Recommends Transition Away from LIBOR

By Lene Powell, J.D.

Referring to LIBOR and other interest rate benchmarks, CFTC Chairman Gary Gensler said that "continuing to reference such rates diminishes market integrity and is unsustainable in the long run." In prepared remarks delivered to the Global Financial Markets Association's Future of Global Benchmarks Conference, the chairman said that although moving on from LIBOR may be "challenging" and "unpopular," it was best not to fall prey to accepting that LIBOR or any benchmark is "too big to replace."

LIBOR, or the London Interbank Offered Rate, is the average interest rate at which large international banks report that they can borrow from each other. LIBOR and other interest rate benchmarks are widely used to help determine borrowing costs for consumer financial loans and set the prices of many derivatives products. LIBOR is the reference rate for 70 percent of the U.S. futures market, most of the swaps market, and nearly half of U.S. adjustable rate mortgages, according to Chairman Gensler.

Widespread rate-rigging of LIBOR came to light in 2012, raising doubts about the integrity of the benchmark. Settlements in joint enforcement cases against Barclays, UBS, and the Royal Bank of Scotland resulted in U.S. fines of $2.5 billion, the chairman said.

LIBOR and related rates are compromised by three problems, said the chairman. First, due to shifts in banking practices, the number of transactions that the benchmarks are based on has dramatically declined, and is "essentially nonexistent." It is likely to decline even further due to a number of factors, including the new Basel III capital rules. Without transactions, Mr. Gensler said, the situation is similar to trying to buy a house when your real estate agent can't give you comparable transaction prices because no houses were sold in the neighborhood in years.

Another problem is that the LIBOR rate was readily and pervasively rigged, spanning many years and involving numerous people, offices in several cities, and multiple benchmark rates and currencies, said the chairman. A further problem is that LIBOR is "remarkably much more stable" than any comparable rate, given market volatility. A comparison of LIBOR submissions to the same banks' credit default swaps spreads or to the broader markets' currency forward rates shows a continuing gap between LIBOR and other market indicators, Chairman Gensler stated.

The chairman noted that Martin Wheatley of the FSA recommended that Canadian dollar LIBOR and Australian dollar LIBOR cease to exist so a transition is necessary, at least for those reference rates. There are alternatives to LIBOR, said Mr. Gensler, including the overnight index swaps rate, benchmark rates based on actual short-term collateralized financings, and benchmarks based on government borrowing rates.

A key question is how to address transition, the chairman said. The market does have some experience with transition for smaller contracts, such as for energy and shipping rate benchmarks. The basic components of such a transition include identifying a new and reliable benchmark. The new and existing benchmarks run in parallel for a period of time to allow market participants to transition, said Mr. Gensler.

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