UBS traders colluded with brokers to rig the Libor rate, which is used to price trillions of dollars worth of loans worldwide, rewarding them for their help. They also teamed up with traders at other banks.

The penalty agreed with U.S., UK and Swiss authorities is more than three times the $450 million fine levied on Britain's Barclays in June, also for rigging Libor, and is the second largest fine ever levied on a bank.

"The findings we have set out in our notice today do not make for pretty reading," said Tracey McDermott, head of enforcement and financial crime at Britain's FSA regulator.

Shares in the Swiss bank rose 1.6 percent to hit a 17-month high of 15.5 francs ($16.97)in early trade as dealers said the settlement, which was expected, removed a major uncertainty.

"You can see from the stock movement that the fine is already baked in," said Markus Jordi, principal at Zurich-based investment manager Cosmos Capital.

"The bank has already kicked out some traders, apologized, said it will shut down parts of the investment bank and overhauled management."

The UBS deal is likely to be followed by a raft of other settlements between big banks and regulators over the rate-rigging scandal, which has transformed the London interbank offered rate (Libor), from esoteric financial acronym to household name.

The UBS fine comes a week after Britain's HSBC agreed to pay the biggest ever bank penalty - $1.92 billion - to settle a probe in the United States into laundering money for drug cartels.

UBS's unit in Japan pleaded guilty to one count of fraud relating to manipulation of benchmark rates, including the yen Libor.

BUSINESS WITH INTEGRITY

The revelations are yet another blow for UBS, which over the past 18 months has lost an eye-watering $2.3 billion in a rogue trading scandal, suffered management upheaval and thousands of job cuts.

The impact of the deal on the flow of client funds into the bank will not be known until the first quarter of next year.

"We deeply regret this inappropriate and unethical behavior. No amount of profit is more important than the reputation of this firm, and we are committed to doing business with integrity," UBS Chief Executive Sergio Ermotti said in a statement disclosing the extent of the wrongdoing, which took place over six years from 2005 to 2010.

UBS said it will pay $1.2 billion to the U.S. Department of Justice (DoJ) and the Commodity Futures Trading Commission (CFTC), 160 million pounds to the UK's Financial Services Authority (FSA) and 59 million Swiss francs from its estimated profit to Swiss regulator Finma.

The UK penalty is the largest in the history of the FSA and more than double the 59 million pounds paid by Barclays.

The bank said the fines would widen its fourth quarter net loss to up to 2.5 billion francs but said it would not need to raise new capital.

"Despite the scale of UBS's connection to the Libor scandal, it will perhaps find it easier to put the incident behind it than other institutions given its decision in October to withdraw from or substantially downsize most fixed-income related investment banking activities," said Michael Symonds, credit analyst at Daiwa.

BE A HERO

Britain's financial regulator said at least 45 people were involved in the rigging, which was discussed in internal chat forums and group emails but never detected by UBS's compliance staff, despite five audits.

The FSA said the manipulation was considered to be "normal business practice" by a wide pool of people within the bank.

In addition to traders trying to move the Libor rate up or down to make money for themselves, senior managers at the Swiss bank directed dealers to keep Libor submissions low during the financial crisis to make the bank look stronger.

The extent of the wrongdoing was highlighted in a series of emails released by the FSA which showed how traders and brokers conspired to rig the rate and referred to each other in congratulatory terms such as "superman" and "be a hero today".

In one email, a trader wrote :"I need you to keep it as low as possible ... if you do that .... I'll pay you, you know, 50,000 dollars, 100,000 dollars... whatever you want ... I'm a man of my word".

It is the first time that brokers have been accused of taking payments to aid manipulation. ICAP, the world's largest inter-dealer broker, and rival RP Martin have suspended employees in connection with the probe.

THREAT OF CIVIL LAWSUITS

Britain's FSA said attempts to manipulate Libor and Euribor, its European equivalent, were so widespread that every submission UBS made over a six year period from 2005 to 2010 was suspect.

The Libor benchmarks are used for trillions of dollars worth of loans around the world, ranging from home loans to credit cards to complex derivatives.

Tiny shifts in the rate, compiled from daily polls of bankers, could benefit banks by millions of dollars. But every dollar a bank benefited meant an equal loss by a bank, hedge fund or other investor on the other side of the trade - raising the threat of a raft of civil lawsuits.

In a memo to staff on Wednesday, Ermotti said it was too early to determine whether or how clients were affected, pending further regulatory probing of the rate fixing.

Until the rate-rigging scandal broke, Libor had been ignored by regulators and left up to the banks to police. From next year, Britain's FSA will have oversight of it as part of a major overhaul.

The steep fine for UBS is despite the bank, since 2011, cooperating with law-enforcement agencies in their probes. The bank said it received conditional immunity from some regulators.

A similar admission by Barclays in June touched off a political firestorm that forced its chairman and chief executive to quit. Ermotti said around 40 people had left UBS or been asked to leave the bank as a result of the investigation.

(Additional reporting by Martin de Sa'Pinto, Huw Jones, Blaise Robinson, Sarah White and Steve Slater; Writing by Alexander Smith; Editing by Carmel Crimmins and Anna Willard)

• A Permanent Economic Emergency