FinanceFeeds | LIBOR gets a stay of execution from the Fed

By instigating a six-month stay of execution the US central bank hopes that more of the outstanding, dollar LIBOR linked contracts, will be able to mature without disruption to rate calculations, and therefore aid the transition to SOFR.

Preparations for the demise of the London Interbank Offered Rate (LIBOR) continue .

LIBOR is a key interest rate benchmark that has dominated the worlds of lending and credit for three decades or more, however, over the years it became tainted by scandal and is no longer considered to be fit for purpose.

LIBOR reference rates are due to be discontinued from being calculated and published after the end of 2021, and are set to be replaced by other interest rate benchmarks.

However, moving away from LIBOR in that timescale will be no mean feat, as there is thought to be as much as $200 trillion in outstanding bonds, loans, mortgages, credit agreements, swaps and other instruments, that are linked to LIBOR rates.

LIBOR itself, of course, was never just one rate, but rather a schedule of funding rates for major currencies, over time frames which ran from overnight money to one year, although three-month money was the most widely quoted and referenced figure.

LIBOR’s downfall came about because its values were estimates of the rates that banks would theoretically be prepared to lend money at, in a given currency, over a given time frame, rather than figures that were based on actual transactions, which of course left it open to accusations of manipulation.

The calculation methods for LIBOR were reformed in 2012, following recommendations from the FCA’s Martin Wheatley and responsibility for calculating the rates passed from the British Bankers Association to UK regulators, and Libor rates became transaction-based. The calculations of LIBOR rates are now overseen by the ICE exchange.

The European Parliament and European Council yesterday became the lastest bodies to ratify the proposed moves away from LIBOR, though the European Commission has yet to confirm which benchmark it believes should replace it.

The Sterling Overnight Index Average or SONIA is seen as a leading candidate, as is the Euro Short term rate or ESTR, published by the ECB, and the Secured Overnight Financing Rate or SOFR which is favoured in the USA.

Rather than one reference rate and framework, it seems that there will be a different rate for major currencies, each of which could become a potential national champion.

The scale of the interest rate linked market is such that it’s critical that bankers, regulators and other market participants choose wisely.

Earlier this week, FinanceFeeds reported in detail on the transitional arrangements being put in place in Australia, and the position of the Australian regulators with regard to financial institutions in Australia preparing for the imminent move toward a new system. Australia’s lead will have to be followed by other regulatory authorities which will require financial institutions under their auspices to adhere to a recommended uniform method of transition.

There are officially thirteen months before LIBOR ceases to exist, however it is now possible that this deadline could be extended into 2023 after the US Federal Reserve said on Monday that it is concerned that transition from LIBOR, will not be completed under the current deadline.

By instigating a six-month stay of execution the US central bank hopes that more of the outstanding, dollar LIBOR linked contracts, will be able to mature without disruption to rate calculations, and therefore aid the transition to SOFR.

However, at the same time, American regulators also warned US banks to stop using and issuing LIBOR linked loans by the end of December this year.

Of course, financial markets are no strangers to missed deadlines, the introduction of  MiFID II was famously deferred by a year and it could yet be that LIBOR limps along even beyond the Feds proposed June 2023 deadline.

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