LIBOR Will Be Gone, Now What? – Lee Chandler

LIBOR, which stands for London Inter-Bank Offered Rate, is one of the most important
interest rates in finance. It is the benchmark interest rate based on which global banks
charge each other for short-term loans. It is also a reference rate for adjustable-type
loans such as mortgages, bonds, credit cards, etc.
LIBOR is actually a series of average interest rates calculated by the Intercontinental
Exchange (ICE) with information submitted by an administration panel consisting of 11
to 18 bank contributors. It is calculated and published daily at around 11:45 a.m. EST.
To calculate this index, ICE will ask the participating banks at which rate they are willing
to lend to other financial institutions before 11 a.m. ICE will then exclude any outliers
from this data and take the average of the remaining numbers.
LIBOR plays the role as the lowest lending rate among interbanks. It is also used to
construct instruments such as interest rate swaps or credit default swaps, which insures
banks against defaults. A high LIBOR makes all loans more expensive, and may reduce
consumer demand and slow down economic growth, and in the long run can lead to
recession and unemployment.
If LIBOR is so important, why are people letting it go?
It all starts from the LIBOR scandal in 2012. An investigation conducted in 2012 into
LIBOR found that several major banks such as Deutsche Bank, Barclays, UBS have
plotted to manipulate the LIBOR rate for these banks and their traders’ profits. It was
believed that these manipulations had begun back in 2003. Barclays, one of the main
participators in this scheme, reported that during the economic crisis from 2007 to 2009,
they had misreported the rates so that it would benefit their traders rather than
submitting the actual rates they used. It was later found that some traders at Barclays
had also persuaded other major banks to change their figures submitted as well. It was
also said that Barclays told the LIBOR calculators to downplay the figures in order to
make the banks appear more stable. This major scandal has affected the public trust in
the marketplace. In addition, the significant fines and legal settlements that participating
banks had to pay can also affect their ability to keep a high reserves in case of any
economic crisis.
In 2017, the United Kingdom’s Financial Conduct Authority, which oversees the LIBOR
rate, has announced that this rate will be phased out at the end of 2021 due to its
inability to reflect costs from actual transactions. Later that year, the Alternative
Reference Rates Committee has chosen SOFR as the replacement for LIBOR.

The discontinuation of LIBOR and introduction of SOFR can affect a lot of market
transactions. Firstly, usually contracts do not indicate clearly the possibility of LIBOR
being discontinued, but only provide alternatives for when it is not published. Thus,
businesses now need to pay detailed attention to their contracts where LIBOR is used
to evaluate any risks since one of the parties may benefit from the language being used
currently. Secondly, the transition to using SOFR will be difficult, since this rate is still
new and has not had an established market. In some industries, this rate is also not
preferred as much as other rates such as PRIME or Ameribor. A forward-looking SOFR
rate has also not been established, and is expected to be available by the end of 2021.
Due to the uncertainty and disorder in this year, it is in their best interests that
businesses should start assessing their inventory and exposure, developing contract
amendment or renegotiation strategies, developing a response program, and most
importantly, getting used to a new reference rate.
Thuong Nguyen
Sources:
London Inter-Bank Offered Rate (LIBOR):
https://www.investopedia.com/terms/l/libor.asp
Libor, How It’s Calculated, and Its Impact On You: https://www.thebalance.com/what-is-
libor-how-it-s-determined-and-how-it-affects-you-3305858
LIBOR – Definition, Overview, Process of Calculating LIBOR:
https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/libor/
How is the LIBOR rate calculated?
https://www.marketbeat.com/financial-terms/how-libor-rate-is-calculated/
Understanding the Libor Scandal:
https://www.cfr.org/backgrounder/understanding-libor-scandal
LIBOR Phased-Out: What Does It Mean For You?
https://www.schwab.com/resource-center/insights/content/libor-phase-out-what-does-it-
mean-you
What’s Next For LIBOR Transition in 2020?

https://www.abfjournal.com/articles/whats/

By admin

Leave a Reply

Your email address will not be published. Required fields are marked *