UK watchdog says markets fared well in recent volatility

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By Huw Jones

LONDON, March 1 (Reuters) - Markets handled a recent bout of extreme share-price volatility without widespread fallout, but they need to remain vigilant as new bets are laid on price swings, Britain's top markets regulator said on Thursday.

Financial instruments that bet on calm stock markets suffered a rout in early February as volatility roared back on Wall Street, sending blue chips sharply lower

Andrew Bailey, chief executive of the Financial Conduct Authority, said the volatility may have been exacerbated by the "herding effect" of several big players closing out leveraged volatility-based investment strategies.

But falling share prices were not accompanied by major fallout elsewhere in markets, he said. The system stabilised and the episode was short-lived.

"So, let's not get carried away," Bailey said in a speech. "There are, however, already some indications that short volatility positions are beginning to be re-established."

The volatility came just after the European Union introduced a sweeping reform of securities trading, known as MiFID II, in January. The new systems stood up to the test, Bailey said.

One central element of MiFID II, a volume cap on trading shares "in the dark" or off an exchange, was delayed until this month because of its complexity.

Bailey said he was "relaxed" that the cap will be introduced without disrupting markets.

Markets now face another big change in moving from using the London Interbank Offered Rate, or Libor, for pricing financial contracts to alternatives from central banks in Britain, Switzerland, Japan and the United States.

Banks were fined billions of dollars for trying to rig Libor, and the FCA has set an effective cut-off date of the end of 2021 for moving from Libor to the "preferred" alternative, an overnight rate administered by the Bank of England for sterling contracts.

Bailey has said too few transactions underpin Libor for it to be sustainable, but market participants have said it may not be possible to switch all outstanding contracts to the new benchmark.

ICE, which administers Libor, has opened up the possibility of a voluntary arrangement among banks to keep Libor going, Bailey said.

"I don't rule this out, but I would stress that I don't see a prospect of a reversal in the decline of the market activity that Libor seeks to measure," Bailey said.

A "synthetic Libor" could help markets deal with legacy contracts, but it would not be accepted by regulators as an alternative to the BoE (Shenzhen: 000725.SZ - news) rate, Bailey said.

(Reporting by Huw Jones; editing by Larry King)