FRANKFURT, Nov 14 (Reuters) - The European Central Bank is demanding an overhaul of the system for setting market interest rates in the euro zone in the wake of a scandal that engulfed banks setting the rival Libor benchmark rate.
In its response to a European Commission consultation on the future of the 'Euribor' rate, the ECB and the 17 national central banks under its umbrella said the system needs more transparency and actual data instead of just banks' estimates.
There is "significant scope for Euribor reform," the bank said.
Euribor, the euro interbank-offered rate, and its larger counterpart the London Interbank Offered Rate (Libor) are Europe's key gauges of how much banks pay to borrow from peers. The two rates underpin swathes of financial products from Spanish mortgages to derivatives contracts in London.
Regulators are plotting a way forward after manipulation of Libor led to fines of $450 million for Barclays, hardening resolve for a regulatory overhaul of the methods used to set the price of credit.
Anti-trust authorities are still investigating possible manipulation of the Euribor.
Amid a collapse in interbank lending following the financial crisis, the ECB said Euribor reform should first address short-term fixes for the benchmark to regain confidence and then move on to more complete reform in the longer term.
"In the short term, the focus should be on improving the governance process, as well as on providing a clear road map for both the regulation and supervision of Euribor," the ECB paper said.
"An increased reliance on transaction-based figures in the calculation of Euribor should be beneficial... at a later stage."
The ECB, however, shied away from offering to supervise the system, saying that European Securities and Markets Authority (ESMA) and European Banking Authority (EBA) are better placed than itself, as this would limit conflicts of interest.
Moreover, the central bank urged cooperation at the European and global level to ensure consistency.
It proposed setting up a system of 'Chinese Walls' within banks, which would minimise risk of improper influencing of rates.
"Introducing changes to the legal nature of the Euribor Code of Conduct for contributing panel banks to make it binding" should be analysed further, it said.
As this step could be tricky - it could discourage banks from participating as they could face legal sanctions - the ECB proposed limited sanctions, such as suspension from the panel.
At the same time, eligible banks should be encouraged to participate, and even the option of compulsion should be considered.
In the longer term, Euribor should move toward a more transaction-based approach, where estimates could still play a role.
"One promising solution may be represented by the option to combine transaction-based data with survey-based estimates," the paper said.
It rejected scrapping Euribor in favour of an alternative, referring to long-standing contracts and saying such a change could "entail significant legal and financial stability risks".
Moreover, it is important that, despite a rise in collateralised lending, there is a need for a benchmark rate for unsecured funding costs.