End of LIBOR Part 1

22 Aug

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End of LIBOR Part 1

What you need to know before LIBOR disappears – Impact on Swaps and Variable Rate Debt

The History

The LIBOR scandal that emerged in 2008 highlighted a crucial flaw in the setting of LIBOR rates. Without enough direct trades from which to draw, some traders responsible for setting the rates via daily submissions were actually manipulating the rates for their own benefit. Reforms that followed the scandal sought to establish a reliable and credible LIBOR rate-setting process. However, as direct bank to bank trading has not recovered to pre-2008 levels, the UK Financial Conduct Authority (FCA) recently announced its intention to develop an alternative to LIBOR by 2021. The move to replace LIBOR is not driven by suspicions of wrongdoing, but by ongoing concerns that it is no longer reflective of an actual market level.

The Problem

LIBOR is regulated by the FCA and is administered by the Intercontinental Exchange (ICE), an electronic trading platform. In calculating LIBOR, ICE relies on daily submissions from 15 to 20 banks that estimate the rate at which they could borrow unsecured funds from each other. “Estimate” is key since there are very few actual transactions in which banks borrow from one another. As regulator, the FCA spends considerable time persuading banks to continue submitting LIBOR estimates. The lack of an active interbank market in unsecured loans on which to calculate LIBOR led the FCA to conclude that LIBOR may not be sustainable as it no longer reflects market levels.

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