Derivatives, banking and asset management industry sources say the UK's financial watchdog has a tricky balancing act to win back confidence in the London Interbank Offered Rate, that was rigged by Barclays and other banks.

Martin Wheatley, the Financial Services Authority's managing director who has warned banks to clean up their act, faces global calls for speedy reform of the Libor rate as well as pressure from cautious users who are resisting radical change.

Wheatley is expected to recommend on Friday the use of actual market trades rather than quotes to compile Libor and to formally end the role of the British Bankers' Association (BBA) in overseeing it in favor of more formal regulation.

The BBA said on Tuesday that it would support any recommendation by Wheatley for a change of responsibility.

The government is set to include some of Wheatley's proposals in a financial law now being finalized in parliament.

The FSA needs to demonstrate Britain is serious about reform to quell domestic and international anger and to restore faith in its banking industry after Barclays was fined a record 290 million pounds in June for rigging the benchmark.

UK, U.S. and other authorities are investigating other banks, with Britain's Royal Bank of Scotland expected to be the next to settle manipulation charges.

The BBA took control of Libor in 1986 and now covers a suite of 150 rates in different currencies and maturities, forming the basis for pricing financial contracts worth $350 trillion globally, from home loans to credit cards.

HOW FAST AND HOW FAR

The rate is compiled by a panel of banks submitting quotes at which they believe they could borrow from their peers.

Wheatley will recommend sanctions for trying to rig the rate as this currently escapes European Union market abuse rules. Governance of the rate-setting process will also be tightened.

His biggest challenge will be how fast and far to change Libor's composition by including actual market transactions.

Wheatley has suggested scrapping less liquid, longer maturity Libor rates, and combining bank quotes and market transactions for compiling the remaining short-term benchmarks for now, until alternatives are found in the longer term.

Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission (CFTC), which fined Barclays in June, is pressing for swift changes, saying Libor should simply be based on actual market transactions.

"If benchmark rates don't have transactions to rely on, the credibility and reliability of the benchmark is limited," Gensler told the European Parliament on Monday.

"EVOLUTION NOT REVOLUTION"

Users of Libor fear market disruption.

"It's critical that we restore market confidence in Libor by evolution rather than revolution. We don't believe a single alternative benchmark can replace Libor," said Joanna Cound, European head of government affairs at BlackRock, the world's biggest asset manager.

Supervision is another sensitive area as Wheatley will scrap the BBA's sole oversight role for Libor so that it is directly supervised by regulators. What is unclear is which supervisor will end up with this role.

U.S. regulators like Gensler and the European Central Bank, due to become the main supervisor for euro zone lenders, will want a say on Libor rates linked to their currencies.

The EU's financial services chief Michel Barnier told the European Parliament on Monday there should be international coordination of Libor with enforcement done regionally, meaning Brussels not London.

Gensler and Wheatley co-chair a newly-created global regulatory task force to forge a common approach to Libor and iron out potential clashes.

Wheatley has warned that while regulators can impose conditions on how benchmarks are put together, they cannot force markets to use them.

Thomson Reuters, parent company of Reuters, calculates and distributes Libor rates for the BBA.

(Additional reporting by Kirstin Ridley; Editing by Alexander Smith)

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