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David Woolcock 07-Nov-2018 11:23:21 8 min read

LIBOR - Living on Borrowed Time?


LIBOR is going nowhere fast. With $370 trillion of outstanding notional swaps tied to it, the desire to wean markets off this popular fix is going to be a long hard slog. The reasons for removing LIBOR are well rehearsed and the underlying intellectual rigour behind the arguments were compelling before the deluge of rate rigging allegations appeared. 

The main argument against was that it is a subjective rate relying on a bankers judgement rather than an analytical evaluation of underlying transactions. Following publication of rigging allegations, it was easily demonstrated that parties with bad intentions could relatively easily manipulate the reference rate based on their own submissions. 

What has also contributed to this sorry state of affairs for LIBOR is a lack of underlying unsecured bank-to-bank transactions. Regulatory and capital requirement changes have pushed banks to conduct short-term interest rate operations in other markets, mainly those that are collateralised. Many consider the FCA rang the “Death Bell” for LIBOR, and like the South Korean film of the same name, getting rid of LIBOR is going to need many questions answered. Andrew Bailey, FCA CEO, announced the end of banks needing, or indeed being compelled, to submit LIBOR when concluding a speech in July 2017 – 

“Work must therefore begin in earnest on planning transition to alternative reference rates that are based firmly on transactions. Panel bank support for current LIBOR until end-2021 will enable a transition that can be planned and can be executed smoothly. The planning and the transition must now begin.” 

During the crisis, regulatory pressure was brought to bear on banks to continue submitting LIBOR rates. The administrator changed to the Intercontinental Exchange (the ICE) and their Benchmark Administration Arm (IBA). As a result, it now conforms to the various regulations and best practice from bodies such as IOSCO and regulator driven benchmark requirements and is authorised under the EU Benchmarks Regulation amongst others. This ringing of the “Death Bell” by the FCA made it clear banks will not be in any way compelled to make LIBOR submissions from 2022 onwards. This has raised an enormous volume of work on alternatives and a lot of thought to what do you do about legacy contracts that mature post 2021. 

LIBOR originated in the 1980’s as an industry (mainly banks) led initiative co-ordinated by the British Bankers Association (BBA) with assistance from the Bank of England. LIBOR’s reach is massive and along with Euribor, it is the primary source of benchmarks for short-term interest rates around the world. However, post 2021 the industry faces the risk that banks may not voluntarily make submissions and so work has been ongoing to create suitable replacements in multiple jurisdictions. The replacements are based on real transactions and so are a lot more difficult to manipulate. The two most advanced are the United States and the UK. 

For the United States, the Alternative Reference Rates Committee (ARRC) has announced a preferred alternative, which is the Secured Overnight Financing Rate (SOFR) and is a measure of the cost of borrowing cash overnight collateralised by Treasury Securities and is based on a large volume of actual transactions. In the UK, the Risk Free Working Group selected the reformed Sterling Overnight Index Average (SONIA) and again it is based on a large volume of actual transactions. Others are following suit with EONIA in Europe, the Swiss SARON and Japan’s TONAR being other examples. To shift to using these new benchmarks is going to take an awful lot of effort by all stakeholders over the next four years. Of course, the IBA may continue to publish LIBOR benchmarks post 2021 but we need to be cognisant of the risks involved if the banks do stop contributing at that point. 

From today (and indeed really from our yesterdays), we need to consider how to deal with the legacy contracts that reference LIBOR. We must include a fall-back in documentation of LIBOR based transactions that mature post 2021 in the event that LIBOR rates are not published. At the same time, there is a need to develop deep and liquid markets in the proposed new benchmarks. No small task in just three to four years! Other industry groups are pitching in to help, such as the International Swaps and Derivatives Association (ISDA) and further news following their consultation is expected sometime next year. This should help clear up the basis risks involved to a certain extent. The bottom line is we need to act now. Delay could be very costly. 

The impact also goes further; banks that model their own requirements under the Fundamental Review of the Trading Book (FRTB) are asking regulators for some relief as liquidity in LIBOR-based swaps diminishes and liquidity builds up in replacement benchmarks. Look out for an upcoming blog on the changes FRTB will bring in. This is scheduled to be implemented in 2022 after a three-year extension and needs to be planned for now in order to meet the date with destiny! 

Eurobase Banking Solutions will be hosting a breakfast briefing “Lest we Forget – The New Horizons for Treasury Regulation.” At this informative briefing we will look at the legal, (a lawyer will join us to talk us through these aspects as litigation is bound to be involved), and the technical issues that a change to benchmarks entails. Alongside this, we will detail the ramifications for banks of the FRTB one of the threats on the distant horizon that needs the quarterdeck manned and prepared for now. On top of this, we will look at The European Union (EU) Securities Financing Transaction Regulation (SFTR) scheduled for Q3 2019. You can access our recent SFTR blog at Then to top off the breakfast pastries we will cover the risks and opportunities of cryptocurrency trading and the new, but exciting, developments in the Institutional market.   

The speech from which I quoted by Andrew Bailey was entitled “Staying Connected” and we are pleased to follow this excellent advice by hosting this timely and very topical breakfast briefing on the 21st of November 2018. “Ahoy Mateys, Avast Ye on the quarterdeck to scan the not so distant horizons”. See you there………………….



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David Woolcock

David Woolcock is an independent consultant and Director, Business Consulting at Eurobase. In addition, David is Chair of the Committee for Professionalism at ACI – The Financial Markets Association as well as Vice-Chairing the ACI FX Committee. He is also a member of the Market Practitioners Group for the Bank of International Settlement's FXWG that wrote the FX Global Code.