LIBOR Transition: Why you should be concerned

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LIBOR Transition: Why you should be concerned

Late December 2021, I received a mail from my bank informing me of their preparation to transition from LIBOR. So, I asked myself “What has that got to do with me?” I believe anyone who received similar email would ask the same question.

The transition from LIBOR is a result of the announcement from Financial Conduct Authority (FCA), regulator of the financial services industry in the UK, on the end of LIBOR usage – effective December 31, 2021.

In effect, LIBOR will no longer be used as a pricing benchmark. But what is LIBOR? Why is it being discontinued? How does this transition affect corporations and businesses, and to a larger extent the individual bank customer?

LIBOR – What is it?

The London Interbank Offered Rate, popularly referred to as LIBOR, is a key interest rate benchmark used in calculating and setting interest rates on mortgage loans, corporate debt, adjustable-rate loans, asset-backed securities. For over 4 decades, the LIBOR served as globally acceptable benchmark rate and has been used extensively in setting interest rates for other financial products across various jurisdictions.

It was calculated in 5 major currencies: UK pound Sterling, the Swiss franc, the euro, Japanese yen and the U.S. dollar, and hence its popularity. Even though LIBOR is no longer in use, effective end-December 2021, assets already priced using LIBOR will survive till June 2023.

But why the discontinuation? The answer is simply ‘LIBOR scam!’ International financial institutions came under investigation by financial regulators across the world, for conspiring to manipulate LIBOR prior to the 2008 global financial crisis in order to make profits. In fact, according to the Council on Foreign Relations (CFR), banks have been fined over US$9billion for rigging LIBOR – which was used in pricing over US$300trillion worth of loans worldwide!

As LIBOR is being wound-down, the Financial Stability Board (FSB) is coordinating international efforts to recommend alternative Risk Free Rate (RFRs) to LIBOR with respect to jurisdictions. Below are the recommended RFRs that can be used in LIBOR’s stead:

RFRs recommended as alternatives to LIBOR

JurisdictionAlternative Ref. Rate NameAdministrator
United States of AmericaSecured Overnight Financing Rate (SOFR)Federal Reserve Bank of New York
United KingdomSterling Overnight Index Average (SONIA)Bank of England
SwitzerlandSwiss Average Rate Overnight (SARON)SIX Exchange
JapanTokyo Overnight Average Rate (TONAR)Bank of Japan
Euro areaEuro short-term rate

(€STR)

European Central Bank

Source: Financial Conduct Authority (FCA)

In August 2021, the IFC led the transition from LIBOR to SOFR as it successfully issued a US$2billion fixed-rate five-year US$ dominated bond, which attracted strong investor demand; demonstrating IFC’s support for the use of alternative reference rates, in this case SOFR.

LIBOR transition and you!

The transition from LIBOR to alternative reference rates such as SOFR, SONIA, TONAR, etc., has significant effects on businesses and individuals. As noted earlier, LIBOR is used as a benchmark in calculating interest for mortgages, student loans and other asset-backed securities.

In effect, when an individual applies for a mortgage loan, after the transition an alternative reference rate will be used as a benchmark to calculate the interest rate on the mortgage. As a concerned bank customer, it is best to ask your financial institution which benchmark interest rate will be used.

For corporate institutions that financed their operations using syndicated debt, LIBOR was a key benchmark interest rate used to determine the cost of borrowing. However, with the transition, alternative reference rates will apply with respect to the jurisdiction. For instance, if a corporate institution requires debt financing from syndicated banks in the UK, SONIA will be the benchmarking interest rate applied.

At this point, you will acknowledge that for the sake of transparency and fairness, your bank deemed it fit to inform you of the transition.

References:

Financial Conduct Authority (FCA), Mortgage interest rates and LIBOR: information for borrowers [10/06/2021]: https://www.fca.org.uk/consumers/mortgage-interest-rates-libor

Forbes Advisor, What Is Libor And Why Is It Being Abandoned? Miranda Marquit and Benjamin Curry [12/21/2021]: https://www.forbes.com/advisor/investing/what-is-libor/

GlobalFTI, Learning LIBOR: https://globalfti.com/learning-libor/

Council on Foreign Relations, Understanding the Libor Scandal: https://www.cfr.org/backgrounder/understanding-libor-scandal

International Finance Corporation (IFC), IFC Leads Transition to SOFR with Landmark $2 Billion Bond Issuance: https://pressroom.ifc.org/all/pages/PressDetail.aspx?ID=26610

 

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