We outline key steps necessary to reform the London Interbank Offered Rate (LIBOR) so as to improve its robustness to manipulation. We first discuss the role of financial benchmarks such as LIBOR in promoting over-the-counter market efficiency by improving transparency. We then describe how to mitigate LIBOR manipulation incentives by: (I) widening the types of transactions used to fix LIBOR; (ii) encouraging a transition of "rates trading" applications of LIBOR derivatives to alternative reference rates that are in principle more suitable for this purpose because they do not include the bank-credit-spread component inherent in LIBOR. The current exceptional depth and liquidity of LIBOR-based markets are self-fulfilling sources of dominance for LIBOR as the reference rate of choice among rates traders. This liquidity agglomeration around LIBOR is probably accidental and inefficient, and creates an incentive to manipulate LIBOR. A transition of rates trading to alternative reference rates, however, may be difficult to arrange without official-sector involvement.
