The end of Libor as we know it may soon be upon us, as calls for an overhaul of the rate-setting process mount.

Gary Gensler, the chairman of the Commodity Futures Trading Commission, the top U.S. derivatives regulator, yesterday told a European parliament hearing into the Libor scandal that only a major revamp of the rate-setting process would restore faith in the system. He told MEPs that, at times, the Libor rate appeared divorced from market reality.

Regulators in Europe and the U.S. continue to struggle to come up with any concrete method for determining Libor, despite admitting the system is flawed. The Libor rate is used as a benchmark interest rate for around $800 trillion of derivative and debt contracts around the world and implementing an alternative may well severely disrupt financial markets.

European Union lawmakers also want to introduce, by the end of this year, tougher market abuse punishments, including jail sentences, for bank staff found guilty of collusion to fix the Libor lending rate.

“The only thing that’s not possible is self-regulation or the status quo,” Michel Barnier, the European Union’s financial services commissioner, told the European parliament hearing yesterday.

Market participants also want to see tougher controls introduced to monitor the financial system so that investor confidence can return.

One group, which also testified to the European parliament yesterday on the Libor scandal, believes that only a far-reaching solution to the problem will see some trust restored to financial markets.

“Benchmarks with a large public impact should not be left purely to private interests,” said Thierry Philipponnat, secretary-general of Finance Watch, a Brussels-based group that aims to serve as a counterweight to the financial industry.

The idea of ‘effective self-regulation’ has proven over and over again to be an oxymoron in financial services and is not the way to restore the public’s profoundly shaken trust in the fairness of financial activities.

“When a small group of private actors (panel contributors) works together with a single private interest body (trade organization or an index/commodity price publisher) to set rates with implications for the economy and the global financial system, then the public interest will be at best ignored and at worst exploited, as we have seen. This situation is inherently unhealthy.

“If we are to restore trust in the financial system, supervisors must be able to control conflicts of interest. This includes situations where an entity can be both judge and jury, where there is moral hazard, and where private actions have large consequences for the public interest.”

The integrity of Libor, or the London interbank lending rate, was brought into question in June when Barclays was hit with a record fine of $451 million from regulators in the U.K. and U.S after Britain’s second biggest bank admitted to manipulating Libor from 2005-2009 to the benefit of its derivative positions as well as by a desire to make the bank look stronger during the financial crisis. Other banks are likely to be implicated in the scandal.

Libor, which is is commonly used for sterling and U.S. dollar denominated instruments, is a notional rate set by a 16-bank panel based in London. Members of the panel of international banks are all asked how much it would cost to borrow from one and other and the rate is then calculated and published daily by market data vendor Thomson Reuters on behalf of the British Bankers’ Association, a trade association, covering a variety of currencies and time durations. The Euribor rate, which is used for euro denominated agreements, and is also under investigation, is derived in a similar way to Libor.

Since the scandal broke in late June, calls have grown for changes to the rate-setting system. In late July, the U.K. government set up a review that is being conducted by Martin Wheatley, a top official at the Financial Services Authority, which is looking into how Libor is calculated and regulated. An initial discussion paper has said that a dramatic overhaul of the key benchmark borrowing rate is needed.

“The fact that we have Gary Gensler, chairman of the U.S. Commodity Futures Trading Commission, who exposed the Libor scandal in the U.S., and both European commissioners Barnier and [Joaquín] Almunia giving evidence to the hearing, reflects the gravity of the situation and the need for urgent reform,” said Arlene McCarthy, a left-of-center U.K. MEP who is vice-chair of the European parliament’s influential Economics and Monetary Affairs Committee and is also the parliament’s rapporteur on the European Union legislation on market abuse.

“It is important that we learn the lessons from this crisis and ensure we have a robust legal and regulatory framework to prevent future manipulation or abuse and its potentially devastating consequences for the European and global economy and the continued crisis of confidence in banks and financial markets.

“We have moved swiftly to take action by amending the current market abuse rules by widening the scope to cover key interest rates such as Libor and Euribor and other systemically important benchmarks and indices. The culture of the banking industry has not changed and this culture was aided and abetted by regulatory failures.”