Libor, the interest rate at the centre of an international rate-rigging investigation, must not be scrapped hastily and any shift to alternatives should be gradual to avoid market disruption, the derivatives industry's leading global body said.
Reform of the London interbank offered rate is inevitable after Barclays and Royal Bank of Scotland (RBS) were hauled before British and U.S. regulators. Barclays was fined a record $450 million in June for attempted manipulation of the rate and RBS is expected to be the next bank to settle.
Britain's Financial Services Authority is publishing its recommendations for legal changes to Libor on Sept. 28.
However, the prospect of changes to a benchmark used as a basis for pricing $350 trillion of products from home loans to credit cards has alarmed the derivatives market, a major user of the rate for its complex financial products.
Stephen O'Connor, chairman of the International Swaps and Derivatives Association (ISDA) and managing director of Morgan Stanley, said on Thursday that Libor remained hugely relevant economically and is necessary for the off-exchange derivatives market to function properly.
Replicating Libor across derivatives would be a very large and difficult task, he told the ISDA's annual conference. "Libor must continue to be published."
The authorities should encourage banks to continue to participate in setting Libor in the short and medium term until a longer-term solution is in place, O'Connor added.
Libor is compiled by a panel of banks submitting quotes for the interest rate at which they believe they could borrow from one another.
Reform of Libor governance and setting was needed, O'Connor acknowledged, but he said that the transition of existing contracts to a new regime must be very carefully planned and managed.
"There are limits to the amount of change that can be accommodated," he said.
Hasty changes might see market participants claiming that the nature of their existing contracts are different to what was originally intended, which could spark disruptive legal issues.
The ISDA, which represents the bulk of the banks and other participants in the world's $650 trillion derivatives market, said it would be able to make changes required by regulators for new contracts based on a reformed Libor or alternatives that are backed by users.
"Even the regulators understand they are not going to be in any position to impose a new rate on markets," ISDA Chief Executive Robert Pickel said.
O'Connor expects regulators to supervise Libor more directly but to stop short of producing the benchmark rate themselves.
Thomson Reuters, parent company of Reuters, has been calculating and distributing Libor rates for Libor's sponsor, the British Bankers' Association, since 2005.
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