Each business day, shortly before 12:00 p.m. London time, the London Interbank Offered Rate, or LIBOR, is published. The rate, which is the average of up to 20 banks’ estimates of the interest rate at which they can borrow from other banks, is a benchmark for financial contracts estimated to be worth approximately $350 trillion, including corporate loans, mortgages, derivatives, and tax-exempt bonds. However, the rate’s days appear to be numbered, and market participants must prepare for the possibility that LIBOR will no longer be published beyond the end of 2021.
Background
LIBOR has been under increased scrutiny recently due to allegations of rate manipulation. During the 2007-2008 financial crisis, the market on which LIBOR is based largely stalled, leaving LIBOR subject to arbitrary determination and, in some cases, deliberate manipulation. In 2015 and 2016, five bankers were jailed for conspiracy to manipulate LIBOR. Only after the financial crisis did Britain’s Financial Conduct Authority (“FCA”) start overseeing the market through its administrator, the ICE Benchmark Administration (“IBA”). While significant controls have been imposed in the setting of LIBOR, there remains insufficient underlying market activity for unsecured wholesale term lending to banks, and LIBOR is feared to implicitly incorporate banks’ own credit risk. As a result, regulators and market participants have begun to question the future of the rate.
The Future of LIBOR
In a July 27, 2017 speech (full transcript available here), Andrew Bailey, Chief Executive of the FCA, acknowledged that LIBOR’s underlying markets have worn thin: “In our view, it is not only potentially unsustainable, but also undesirable, for market participants to rely indefinitely on reference rates that do not have active markets to support them.” For this and other reasons, the FCA requests that banks continue to voluntarily sustain LIBOR until the end of 2021, but no further. While the rate may continue to be issued, there is no guarantee that it will be published beyond such date.
Alternate Rates
In April, a working group convened by the Bank of England concluded that the Sterling Overnight Interbank Average Rate, or SONIA, is its preferred alternative rate. In June, a committee of 15 banks established by the U.S. Federal Reserve proposed a broad Treasury repurchase, or repo, rate for U.S. financial contracts. The repo rate is intended to reflect the cost of borrowing cash secured against U.S. government debt, and the Federal Reserve Bank of New York plans to begin a voluntary phase-in of the repo rate next year. The euro’s overnight rate EIONIA, Swiss SARON, and Japan’s TONER, each anchored in active overnight markets, have also been discussed as alternatives to LIBOR. Time will tell which alternate interest rates gain popularity.
Transitioning to New Rates
As Baily acknowledged, a “transition away from LIBOR will take time,” and “[m]arket participants must take responsibility for their individual transition plans” (though the FCA and other authorities will be available to support planning and transition). Financial institutions and others who rely on LIBOR as a reference rate should begin preparations now to either amend contracts that will survive end-2021 to specifically provide alternative rates, or ensure the inclusion of robust fallback and rate replacement procedures if LIBOR ceases to be published.
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