George Osborne says using trade data in setting Libor to be considered

Bloomberg reports that

U.K. Chancellor of the Exchequer George Osborne set out guidelines for a review aimed at preventing the manipulation of Libor, saying it should consider whether the benchmark should be based on actual traded rates rather than those banks choose to report.

The report by Martin Wheatley of the Financial Services Authority will form the basis for amendments to legislation currently making its way through Parliament. Wheatley is due to present his findings by the end of September, the Treasury said. 

“It is clear that urgent reform of the Libor compilation process is required,” Wheatley said in a statement released by the Treasury in London today....

Regulators must now find a balance between restoring credibility and minimizing disruption to Libor, the benchmark for more than $500 trillion of securities, including $350 trillion of interest-rate swaps and $10 trillion of loans, according to the U.S. Commodity Futures Trading Commission. Any material changes to the mechanism for setting Libor risks invalidating millions of existing financial contracts, lawyers say....

Because submissions aren’t based on real trades, the potential exists for the benchmark to be manipulated by traders hoping to profit on where the rate is set.

With Barclays' admission, it is not a question of potential for the benchmark to be manipulated, but rather a matter of fact.

That has spurred calls for regulators to base the rate on how much banks pay to borrow unsecured cash rather than estimates of how much they might have to pay if they were to borrow. 

“The idea that one can base the future calculation of Libor on the idea that ‘my word is my Libor’ is now dead,” Bank of England Governor Mervyn King said at a press conference to present the central bank’s Financial Stability Report in London on June 29. 

“It will have to be based in the future, in my judgment, on actual transactions in order to bring back credibility to the system.’

Regular readers know that banks need to disclose these actual transactions as part of disclosing on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

This broader disclosure is necessary so that market participants with deposits to lend can independently assess the current risk of the banks looking to borrow.  Without this ability to independently assess the risk of the borrowing banks, the interbank lending market will remain frozen.