U.K. Libor Review to Consider Using Trade Data to Set Rates

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.

Barclays Plc (BARC), the U.K.’s second-largest bank, was fined a record 290 million pounds ($455 million) last month for attempting to rig the London interbank offered rate and Euribor, its equivalent in euros, to appear more healthy during the financial crisis and boost earnings before it. At least 12 banks including Royal Bank of Scotland Group Plc and Deutsche Bank AG are being investigated for manipulating Libor.

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.

Possible Sanctions

The review will include establishing a governance structure for setting the rate and will determine sanctions for any form of abuse. It will consider the scope of powers civil and criminal authorities should have and whether other price-setting mechanisms in markets need to be policed.

Wheatley will publish a discussion paper determining the scope and detail of the review on Aug. 10, to which interested parties will have four weeks to respond.

Libor is determined by a daily poll carried out on behalf of the British Bankers’ Association that asks banks to estimate how much it would cost to borrow from each other for different periods and in different currencies.

Euribor is overseen by the European Banking Federation in Brussels. The rates, an indicator of the cost of money, are used to set prices for securities from mortgages to car loans.

‘Now Dead’

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. 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.’

To contact the reporters on this story: Gonzalo Vina in London at gvina@bloomberg.net; Liam Vaughan in London at lvaughan6@bloomberg.net

To contact the editors responsible for this story: James Hertling at jhertling@bloomberg.net; Edward Evans at eevans3@bloomberg.net

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