In a July 2017 speech, Andrew Bailey, the CEO of the U.K.’s Financial Conduct Authority (FCA), which has regulated LIBOR since 2013, stated, “Our intention is that, at the end of [2021], it would no longer be necessary for the FCA to persuade, or compel, banks to submit to LIBOR. It would therefore no longer be necessary for us to sustain the benchmark through our influence or legal powers.”
After more than four decades as the world’s most widely used benchmark interest rate, referenced by approximately $240 trillion worth of financial products, it appears that LIBOR has but three years to live. What went wrong with LIBOR? What is likely to replace it? What transition plans are in place? What are some of the implications for investors?
Executive Summary
- The London Interbank Offered Rate (LIBOR) is one of the most important interest rates in the world, and is referenced by approximately $240 trillion worth of financial products, across seven different currencies, according to Oliver Wyman. Nonetheless, the Financial Conduct Authority (FCA), the U.K. regulator that oversees its production, has announced its intention to stop compelling banks to provide their estimates for the rate at the end of 2021.
- In 2013, the G20 asked the Financial Stability Board (FSB) to review and reform major reference rates such as LIBOR, which is no longer considered a suitable reference rate for a number of reasons.
- As part of that effort, regulators in various jurisdictions have selected alternative reference rates to LIBOR. In this paper, we focus on U.S. regulators’ selection of the Secured Overnight Financing Rate (SOFR).
- Unlike LIBOR, SOFR is a nearly risk-free rate. It is based on market transactions in the most liquid rates market in the world, covers multiple segments of the U.S. repo market and reflects the activity of a wide array of market participants.
- The plan to transition from LIBOR to SOFR is laid out in a detailed timeline provided by the U.S.’s Alternative Reference Rates Committee (ARRC).
- The end of the LIBOR era should not be a “Black Swan” event, but rather one that market participants should assume to be likely after the end of 2021, and therefore should begin preparing for today.
A Global Snapshot of Alternative Reference Rates
| Currency | Alternative Rate | Secured or Unsecured? | Overnight Rate Available? | Term Rate Available? | Rate Administrator |
|---|---|---|---|---|---|
| USD | Secured Overnight Financing Rate (SOFR) |
Secured | Yes | Planned by end 2021 | Federal Reserve Bank of New York |
| GBP | Sterling Overnight Index Average (SONIA) |
Unsecured | Yes | Under consultation | Bank of England |
| CHF | Swiss Average Rate Overnight (SARON) |
Secured | Yes | Under consideration | SIX Swiss Exchange |
| JPY | Tokyo Overnight Average Rate (TONAR) |
Unsecured | Yes | Under consideration | Bank of Japan |
| EUR | Euro Short Term Rate (ESTER) |
Unsecured | No: To begin October 2019 | Under consideration | European Central Bank |
Source: Oliver Wyman, Neuberger Berman.
