LIBOR to be phased out by end: Transition to new benchmark

Introduction:

The London Interbank Offered Rate (LIBOR) is one of the most widely used benchmark interest rates globally. It is the rate at which banks lend to each other in the London interbank market for short-term loans, typically ranging from overnight to 12 months. The rate is used as a benchmark for a wide range of financial products, including loans, bonds, and derivatives, and it affects the cost of borrowing for businesses and individuals worldwide.

In this blog post, we will explore the history of LIBOR, how it works, its importance, and the recent controversies surrounding it.

History:

LIBOR was first introduced in 1986, and it quickly became the most widely used benchmark interest rate. It was designed to reflect the rates at which large, internationally active banks could borrow unsecured funds from each other. The original panel of banks that contributed to the rate included 16 banks, and the rate was calculated for five currencies: US dollars, British pounds, Japanese yen, Swiss francs, and German marks. Over time, the number of contributing banks increased, and the currencies covered expanded to include the euro and other currencies.

LIBOR, or the London Interbank Offered Rate, has been a key benchmark interest rate for the global financial industry since the 1980s.

Here is a detailed timeline of the history of LIBOR:

1969: The British Bankers’ Association (BBA) is founded, and it starts collecting and publishing interbank lending rates.
1984: The BBA introduces LIBOR as a benchmark rate for international banks operating in London. Initially, it covers five currencies: USD, GBP, EUR, JPY, and CHF.
1986: LIBOR is expanded to include more currencies, including Canadian dollars, Australian dollars, and New Zealand dollars.
1991: The BBA starts publishing LIBOR rates electronically.
1998: The BBA partners with Reuters to launch the first electronic trading platform for LIBOR.
2007-2008: The global financial crisis exposes weaknesses in the financial system, including the reliability of LIBOR. It is discovered that some banks had manipulated LIBOR rates to benefit their trading positions.
2012: Barclays becomes the first bank to settle with regulators over LIBOR manipulation, paying a fine of $453 million.
2014: A number of other banks, including UBS, Royal Bank of Scotland, and Deutsche Bank, are fined for LIBOR manipulation.
2017: The UK Financial Conduct Authority (FCA) announces that it will no longer require banks to submit quotes for LIBOR after 2021, citing concerns about the reliability and sustainability of the benchmark.
2018: The Alternative Reference Rates Committee (ARRC) is established in the US to identify an alternative benchmark for USD LIBOR. It recommends the Secured Overnight Financing Rate (SOFR), a measure of the cost of borrowing cash overnight collateralized by US Treasury securities.
2019: The Working Group on Sterling Risk-Free Rates is established in the UK to identify an alternative benchmark for GBP LIBOR. It recommends SONIA, the Sterling Overnight Index Average.
2020: The COVID-19 pandemic disrupts financial markets and increases concerns about the sustainability of LIBOR. The FCA announces that it will phase out LIBOR by the end of 2021.
2021: The transition away from LIBOR gains momentum, as market participants shift to alternative benchmarks such as SOFR and SONIA. Regulators warn that the transition may be challenging and that there are legal and operational risks to consider. The end of 2021 is set as the deadline for the cessation of all LIBOR tenors.

Overall, the history of LIBOR is one of evolution, innovation, and controversy. While it has served as a critical benchmark for the financial industry for several decades, its limitations have become apparent in recent years, leading to the development of alternative benchmarks and the eventual phasing out of LIBOR.

How it works:

LIBOR is calculated daily by the Intercontinental Exchange (ICE) based on submissions from a panel of banks. The panel consists of banks that are active in the London interbank market and are considered to be among the largest and most creditworthy banks. Each day, the panel banks submit the rates at which they would be willing to lend to other banks in each of the currencies and tenors covered by LIBOR. The highest and lowest submissions are excluded, and the remaining submissions are averaged to calculate the daily LIBOR rate for each currency and tenor.

LIBOR (London Interbank Offered Rate) is a benchmark interest rate that represents the average interest rate at which major banks in London would lend to one another in the interbank market. LIBOR is widely used as a benchmark for a variety of financial instruments, such as loans, bonds, and derivatives, and is calculated and published daily by the ICE Benchmark Administration (IBA).

Here are some key points about how LIBOR works:

Panel of banks: LIBOR is determined by a panel of major banks in London, known as the LIBOR panel. The panel consists of 16 banks, including Barclays, Citigroup, Deutsche Bank, and JPMorgan Chase.
Survey: Every business day, the IBA surveys the LIBOR panel banks to ask at what interest rate they would be able to borrow funds from other banks in the London interbank market for a specified period of time (such as one month, three months, or six months).
Submission: Each bank on the panel submits its own estimate of the rate at which it would be able to borrow funds in the specified currency and time period. The banks are asked to provide an estimate based on what they believe to be the prevailing market conditions and their own creditworthiness.
Calculation: Once all of the submissions have been received, the IBA calculates LIBOR by taking the trimmed arithmetic mean (excluding the highest and lowest submissions) of the remaining submissions.
Publication: LIBOR rates for different currencies and time periods are published daily by the IBA at around 11:55 a.m. London time.
Use as benchmark: LIBOR is used as a benchmark for a variety of financial instruments, including loans, bonds, and derivatives. For example, a floating rate loan might be priced at LIBOR plus a spread, meaning that the interest rate on the loan would be determined by adding a fixed percentage to the current LIBOR rate.
Importance and issues: LIBOR has been the subject of controversy in recent years due to allegations of manipulation by some of the banks on the panel. As a result, efforts are underway to develop alternative benchmark interest rates that are less susceptible to manipulation, such as the Secured Overnight Financing Rate (SOFR) in the United States.

8. Impact on financial markets: The accuracy and reliability of LIBOR are essential to the functioning of global financial markets. Any errors or manipulation of LIBOR can have significant consequences for borrowers, lenders, and investors who rely on it as a benchmark.

9. Transition away from LIBOR: Due to concerns about the reliability of LIBOR and its potential manipulation, regulators and market participants have been working to transition away from LIBOR and to adopt alternative benchmark interest rates, such as SOFR, in the United States and SONIA (Sterling Overnight Index Average) in the United Kingdom. This transition is expected to be completed by the end of 2021.

10. Implications for financial instruments: The transition away from LIBOR will have significant implications for financial instruments that currently rely on LIBOR as a benchmark. For example, contracts that reference LIBOR will need to be amended to reference the new benchmark interest rates. The transition is likely to be complex and time-consuming, and market participants are encouraged to begin planning for the transition as soon as possible.

In summary, LIBOR is a benchmark interest rate that represents the average interest rate at which major banks in London would lend to one another in the interbank market. It is determined by a panel of banks who submit their estimates of borrowing rates for various currencies and time periods, and is used as a benchmark for a variety of financial instruments. However, due to concerns about manipulation, efforts are underway to transition away from LIBOR to alternative benchmark interest rates.

Importance:

LIBOR is used as a benchmark for a wide range of financial products, including loans, bonds, and derivatives. For example, a variable-rate loan may be priced as LIBOR plus a spread. The spread is typically determined by the creditworthiness of the borrower and the type of loan. As LIBOR is the most widely used benchmark rate, any changes in the rate can have a significant impact on the cost of borrowing for businesses and individuals. In addition, the value of many financial products, such as interest rate swaps and futures, is directly linked to LIBOR. Therefore, any changes in the rate can have a significant impact on the value of these products.

LIBOR (London Interbank Offered Rate) is an important benchmark interest rate used as a reference rate for a wide range of financial products such as loans, bonds, derivatives, and mortgages. Here are some key points about the importance of LIBOR:

Global financial markets: LIBOR is one of the most widely used benchmark interest rates in global financial markets. It is used as a reference rate for a variety of financial products, particularly in the international banking and financial sectors.
Lending and borrowing: LIBOR serves as a benchmark for short-term borrowing and lending among banks. Banks use LIBOR to set their own borrowing and lending rates, as well as to price various financial products such as loans and bonds.
Wide range of currencies and tenors: LIBOR is available for several currencies and tenors, ranging from overnight to 12 months. This allows for a wide range of financial products to be priced using LIBOR.
Standardization: LIBOR provides a standardized and widely accepted reference rate that helps to facilitate efficient price discovery in financial markets. This can help to reduce uncertainty and promote transparency in financial transactions.
Importance to consumers: LIBOR affects the interest rates that consumers pay on many types of loans, including mortgages, student loans, and personal loans. When LIBOR rates increase, so do the interest rates on these loans, making them more expensive for consumers.
Hedging and risk management: LIBOR is used by market participants to hedge and manage interest rate risks. For example, a company might use LIBOR to determine the interest rate it will pay on a floating-rate bond.
Importance to investors: LIBOR is an important consideration for investors in fixed income securities, such as bonds. Changes in LIBOR can impact the value of these securities and the returns that investors receive.

In summary, LIBOR is an important benchmark interest rate that plays a significant role in global financial markets. Its importance is due to its widespread use as a reference rate for a wide range of financial products, its standardization, and its impact on consumer loans, hedging, and risk management.

Controversies:

In recent years, LIBOR has been the subject of controversy due to allegations of manipulation. In 2012, it was discovered that several banks had been submitting artificially low rates to benefit their trading positions. As a result, the Financial Conduct Authority (FCA) launched an investigation, and several banks were fined for their role in the manipulation. In addition, there have been concerns about the reliability of the rate, as the interbank market has become less active, and the number of contributing banks has declined. As a result, regulators have been exploring alternative benchmark rates to replace LIBOR.

LIBOR (London Interbank Offered Rate) has been at the center of several controversies over the years. Here is a timeline of some of the major controversies associated with LIBOR:

2008: The Financial Crisis

In the wake of the financial crisis of 2008, concerns were raised about the accuracy and reliability of LIBOR. Some experts argued that the rates submitted by banks to determine LIBOR were artificially low, which could have contributed to the financial crisis.

2011: Manipulation Allegations

In 2011, allegations emerged that some banks had been manipulating LIBOR. It was alleged that the banks had deliberately submitted inaccurate rates to benefit their trading positions, or to appear more financially stable than they actually were.
Investigations were launched by regulators in the US, UK, and Europe into the allegations of LIBOR manipulation.

2012: Barclays Settlement

In 2012, Barclays became the first bank to settle with regulators over allegations of LIBOR manipulation. The bank agreed to pay $453 million to settle the case.
The investigation revealed that Barclays traders had attempted to manipulate LIBOR to benefit their trading positions.

2013: UBS Settlement

In 2013, UBS became the second bank to settle with regulators over allegations of LIBOR manipulation. The bank agreed to pay $1.5 billion to settle the case.

2014: Fines and Prosecutions

In 2014, several banks were fined for their involvement in LIBOR manipulation. Six banks, including Barclays and UBS, were collectively fined over $6 billion by regulators in the US, UK, and Europe.
Additionally, several traders were prosecuted for their role in the manipulation of LIBOR.

2017: End of LIBOR

In 2017, the Financial Conduct Authority (FCA) announced that LIBOR would be phased out by the end of 2021 due to concerns about the accuracy and reliability of the benchmark rate.

In summary, LIBOR has been associated with several controversies over the years, including allegations of manipulation and concerns about its accuracy and reliability. The investigations and settlements resulting from these controversies have resulted in significant fines for banks and prosecutions of individual traders. The decision to phase out LIBOR by the end of 2021 reflects ongoing concerns about the benchmark rate and its role in global financial markets.

Replacement of LIBOR:

Due to the controversies surrounding LIBOR and concerns about its reliability, regulators have been working to develop alternative benchmark rates. In the United States, the Alternative Reference Rates Committee (ARRC) has recommended the Secured Overnight Financing Rate (SOFR) as the replacement for USD LIBOR. SOFR is based on overnight transactions in the U.S. Treasury repurchase market and is considered to be a more robust and reliable benchmark rate.

In the UK, the Working Group on Sterling Risk-Free Rates has recommended the Sterling Overnight Index Average (SONIA) as the replacement for GBP LIBOR. SONIA is based on overnight transactions in the unsecured sterling wholesale funding market and is considered to be a more reliable benchmark rate.

The replacement of LIBOR has been a complex process, with the development of alternative benchmark rates and the implementation of new contracts and financial products. Here is a timeline of the major developments in the transition away from LIBOR:

2017:

The Financial Conduct Authority (FCA) announces that LIBOR will be phased out by the end of 2021 due to concerns about its accuracy and reliability.

2018:

The Federal Reserve Bank of New York establishes the Alternative Reference Rates Committee (ARRC) to lead the transition to a new benchmark rate.
The ARRC selects the Secured Overnight Financing Rate (SOFR) as the preferred alternative to USD LIBOR.
Other countries also begin to develop alternative benchmark rates, such as the Sterling Overnight Index Average (SONIA) in the UK and the Euro Short-Term Rate (ESTER) in the Eurozone.

2019:

The International Swaps and Derivatives Association (ISDA) launches a consultation on fallback language for derivatives contracts referencing LIBOR, to ensure that contracts can transition to new benchmark rates if LIBOR becomes unavailable.

2020:

The ARRC releases recommended language for new contracts referencing SOFR, to facilitate the transition away from LIBOR.
Regulators announce a delay to the cessation of certain LIBOR rates, to provide additional time for market participants to transition to new benchmark rates.

2021:

The UK FCA announces that LIBOR will cease to be published for most currencies at the end of 2021.
The US ARRC releases a set of market best practices for the transition to SOFR.
The ISDA announces the implementation of fallback language for derivatives contracts referencing LIBOR.
Financial market participants continue to transition existing contracts referencing LIBOR to new benchmark rates, and to develop new financial products and contracts referencing SOFR and other alternative benchmark rates.

The process of replacing LIBOR has been ongoing for several years, with the development of alternative benchmark rates, the establishment of industry working groups, and the implementation of new contracts and products. While there have been some challenges in the transition, progress has been made in preparing for the cessation of LIBOR at the end of 2021.

Conclusion:

LIBOR has been a critical benchmark rate for decades, but its recent controversies have raised concerns about its reliability and sustainability. Regulators have been working to develop alternative benchmark rates that are more robust and less susceptible to manipulation. While the transition to these new rates may be challenging and may take time, it is necessary to ensure the stability and integrity of the financial system.

The replacement of LIBOR is a complex process, as it affects a vast range of financial products and markets. Banks, investors, and other market participants will need to transition to the new rates and adjust their pricing models and risk management strategies accordingly. There will also be legal and contractual issues to address, as many existing contracts reference LIBOR. However, with careful planning and coordination, the transition can be managed smoothly.

Here are some useful resources and web links related to LIBOR:

ICE Benchmark Administration (IBA) – The official administrator of LIBOR: https://www.theice.com/iba/libor
Alternative Reference Rates Committee (ARRC) – The group responsible for recommending a replacement for USD LIBOR: https://www.newyorkfed.org/arrc/index.html
Working Group on Sterling Risk-Free Rates – The group responsible for recommending a replacement for GBP LIBOR: https://www.bankofengland.co.uk/markets/transition-to-sterling-risk-free-rates-from-libor
Financial Conduct Authority (FCA) – The UK regulator responsible for overseeing LIBOR and investigating manipulation: https://www.fca.org.uk/markets/libor
Bloomberg – Provides daily LIBOR rates and historical data: https://www.bloomberg.com/markets/rates-bonds/indices/libor
Reuters – Provides daily LIBOR rates and historical data: https://www.reuters.com/article/markets-libor-idUSL3N0QP0SW20140825
Wall Street Journal – Provides news and analysis on LIBOR and the transition to alternative benchmark rates: https://www.wsj.com/news/types/libor

The ICE Benchmark Administration (IBA) website: The IBA is responsible for administering LIBOR and their website provides detailed information about the benchmark rate, its calculation, and methodology.
The Financial Conduct Authority (FCA) website: The FCA is the regulator responsible for overseeing LIBOR. Their website provides updates on the transition away from LIBOR and the development of alternative benchmark rates.
The Federal Reserve Bank of New York’s LIBOR website: The New York Fed provides information on the history of LIBOR, its importance in global financial markets, and the steps being taken to transition to alternative benchmark rates.
The International Swaps and Derivatives Association (ISDA) website: The ISDA is a trade association that represents the global derivatives market. Their website provides information on the transition away from LIBOR and the development of alternative benchmark rates.
The Bloomberg Terminal: The Bloomberg Terminal provides real-time data and news on financial markets, including LIBOR rates. This resource is widely used by professionals in the finance industry.
The Wall Street Journal: The Wall Street Journal provides news and analysis on financial markets, including coverage of LIBOR-related developments.

LIBOR to be phased out by the end of 2021: Transition to new benchmark rates underway

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