LONDON A scandal over the rigging of the Libor interest rate that underpins financial contracts worth hundreds of trillions of dollars is likely to force regulators to reform the way it is set.
But any decision they take will, at best, be a compromise rather than a solution that will fully restore the reputation of what is often referred to as the world's most important financial instrument, many market participants believe.
Libor's credibility was severely damaged during the 2007-2009 financial crisis as some of the banks contributing to its daily fixings were accused of manipulating the rate.
Barclays (BARC.L) was fined $453 million by U.S. and British authorities last week, becoming the first bank to settle in an investigation that is looking at more than a dozen other banks and submissions they made for calculating Libor rates.
Under the terms of the settlement, Barclays will help improve the reliability of the rate-setting system.
Libor rates are used in an estimated $360 trillion worth of financial contracts, ranging from credit cards to complicated derivatives transactions, and it would be almost impossible to replace it quickly with another rate because of the financial and legal chaos it would cause, market participants say.
"It has lost a huge amount of credibility as a benchmark and barometer, but it was always known that it was open to abuse and it was heavily (exposed to) potential conflicts of interest," said Chris Huddleston, head of money markets at Investec.
"(However) there is so much (money) tied up to it that it needs to be fixed rather than replaced," he said.
It is therefore more likely that the way Libor is set and regulated will be overhauled to make it more transparent rather than the instrument being replaced altogether.
Its shortcoming is that it is based on the rate at which a contributing bank says it can borrow funds in the unsecured money market rather that the rate at which it actually obtained a loan. There are no further checks made on its submission.
One way to make the rate-setting process more transparent would be to base it on real transactions. Bank of England Governor Mervyn King has said "the time has now come to move it away from quotes, towards observations based on actual market transactions".
But the euro zone sovereign debt crisis has hit banks so hard that they have been less willing to lend money without collateral, particularly for periods longer than three months.
As a result any reform to Libor may always be imperfect as it may not reflect the true state of the market.
"You can make some improvements to it, but there is no magic wand here," said one London-based interest rate strategist who asked not to be named.
"If there aren't really enough transactions and you need to find an index because you have a huge industry based on it then clearly you need to find a compromise."
There have been a number of attempts to find alternatives. The European Banking Federation has recently launched a dollar Euribor rate, set in Frankfurt. Broker ICAP has launched its own rates, fixed in New York.
There is also talk that the overnight rates - such as Eonia, which is calculated considering volumes of the trades being made - and their derivatives across different maturities could in time become a substitute for euro Libor rates.
But none of these rates is widely used and they are not expected to become the new benchmark, at least in the foreseeable future, due to the sheer number and size of Libor-based financial instruments.
Libor, or the London Interbank Offered Rate, is set for 10 currencies in 15 different maturities from overnight to 12 months. It is compiled daily by Thomson Reuters on behalf of the British Bankers' Association on the basis of contributions from banks in panels chosen for each different currency.
The highest 25 percent and lowest 25 percent of submissions are excluded and the remaining are averaged. For a list of contributors see.
An increase in the number of contributing banks would diminish the impact of any individual contributor and, in theory, should produce a more representative rate.
But a similar attempt by the BBA in 2009 aggravated tensions in funding markets at the time. That move pushed up three-month Libor rates by a couple of basis points as investors worried that weaker banks could push the rate massively higher.
Also, any rate they will submit is likely to be only indicative as "there are perhaps only 10-15 banks that can contribute regularly," said Max Leung, an interest rate strategist with BofA Merrill Lynch Global Research.
Moreover, analysts question how many will be willing to join the group given the potential reputational damage that any connection to the Libor rate might now be perceived to have.
Another way to improve the credibility of the Libor setting would be to introduce a rule to oblige banks to pay their Libor submission rate if they borrow cash after the fixing time around 11.00 a.m. London time (1000 GMT), or else not borrow at all.
Currently, there is no such obligation.
As part of its settlement with regulators, Barclays agreed to help publishers to improve the system. The Commodity Futures Trading Commission, a U.S. futures regulator, said Barclays had agreed to actively "encourage" efforts to make Libor more reliable on six fronts - methodology, verification, investigation, discipline, transparency and formulation.
The BBA, which has overseen Libor since its launch in 1986, said in March it was working on a review that will address issues such as the code of requirements for contributors and strengthening "the statistical underpinning" of the submissions.
A spokesman of the BBA declined to comment on how advanced the review was.
Thomson Reuters said it "supports any measures that create a more robust LIBOR for the benefit of the market and is actively supporting the ongoing reviews".
"Thomson Reuters is proactively in touch with the relevant authorities and parties to suggest ideas on how LIBOR could be further strengthened," an emailed statement said.
The UK government has asked the Financial Services Authority to review the legal framework of Libor and the financial watchdog is expected to publish its findings by autumn.
The BBA has said in the past it had no plans to cede oversight of Libor to regulators, although last week it called on the UK government to review how Libor should be regulated.
(Additional reporting by Emelia Sithole-Matarise, Editing by Swaha Pattanaik and Giles Elgood)