ECB says forex benchmark rates compiled on too narrow basis

(Adds more detail)

By Huw Jones

LONDON, June 18 (Reuters) - The European Central Bank said in a briefing paper on Wednesday that benchmark foreign exchange rates are not necessarily reliable as they are often fixed using just one set of data.

The European Union is in the process of approving a law to regulate market benchmarks after banks were fined for rigging the London Interbank Offered Rate or Libor, an interest-rate benchmark. Global regulators are looking into similar allegations involving banks in the currency markets.

The ECB's view carries weight as the central bank is due to become the euro zone's main banking regulator from November.

In the briefing paper dated June 18, the bank cited market participants as saying that the risk of manipulation of FX benchmark rates comes from improper trading behaviour rather than from weaknesses in how the rates are compiled.

The ECB appeared to focus more on the latter point, however.

"While, in principle, arbitrage across platforms should ensure the conformity of the pricing available on each of them, the fact that the FX benchmarks are often computed with a single primary data source does not fully ensure that benchmark calculations best represent the market during the fixing point of time or window," the ECB paper seen by Reuters said.

"Moreover, in case of illiquid currencies, FX benchmarks are computed from quotes rather than actual transactions," the paper added.

The ECB also said the FX market was getting more fragmented across a number of trading platforms and banks.

There is no precise data on trading but according to market participants and anecdotal evidence, the most widely used FX benchmark is the WM/Reuters 4pm London fixing, it said.

The WM/Reuters fix relates to several exchange rates, including the euro, sterling, Swiss franc and yen set daily in London. These are compiled using data from Thomson Reuters (Frankfurt: TOC.F - news) and other providers, and are calculated by WM Company, a unit of State Street Corp, and are used as reference rates for trillions of dollars worth of investments, trade and corporate deals around the world.

WM Company administers the WM/Reuters Service. Thomson Reuters is a primary source of rates to WM, to which WM applies its methodology and calculates the benchmark.

Thomson Reuters is one of the various distributors of the rate. Thomson Reuters is the parent company of Reuters News, which is not involved in the fixing process.

Other FX benchmarks include the ECB's own reference rates which are sometimes used by asset managers, the paper said.

"Volumes at the ECB reference rates have reportedly increased over the recent months as the ECB reference rates are perceived as independent and reliable," the paper said.

It said market participants say that the risk of manipulation of FX benchmark rates comes from improper trading behaviour rather than from weaknesses in how the rates are compiled.

"To mitigate the risk, some banks have been revising their internal procedures for executing FX transactions at benchmark rates and considering ways to strengthen the application of Codes of Conduct," the paper said. (Reporting by Huw Jones, editing by Matt Scuffham and Hugh Lawson (Frankfurt: LAW.F - news) )