The arduous, decades-long process of ending the financial system’s reliance on the bleak interest-rate benchmark that was once the basis for trillions of dollars in contracts around the world is nearly over. Starting next week, the rate, known as the London Interbank Offered Rate or LIBOR for short, will stop being published.
LIBOR is a collective term for dozens of rates, denominated in various currencies, that are intended to indicate how much it costs banks to borrow from each other. This rate is important because it reflects the base cost that banks pass on to customers. LIBOR movements are reflected in many mortgages, student loans, corporate bonds, and various types of financial derivatives that originated more than 50 years ago.
In 2012, British bank Barclays became the first bank to be fined by regulators for manipulating LIBOR, which was compiled each day by averaging the rates quoted by a relatively small panel of banks. Presentations were supposed to reflect market conditions, but because they were not clearly linked to actual trading, presenters were accused of gaming the system by quoting higher or lower rates to benefit specific trades. Ultimately, allegations of LIBOR rigging resulted in nearly $10 billion in fines throughout the financial industry, which led to efforts to move away from the tainted benchmark.
This week, that mammoth effort is crossing the finish line.
“LIBOR was a ubiquitous rate across all global financial products; It was the most important benchmark in the world, and moving the market away from that has been a really difficult endeavor,” said Mark Cabana, head of US rate strategy at Bank of America. “There are still issues, but it is noteworthy that LIBOR will go out with more of a whimper than a bang. Years ago this was unimaginable.”
In the United States, LIBOR is being replaced by the Secured Overnight Financing Rate, or SOFR. Unlike LIBOR, SOFR represents the cost of borrowing for a variety of market participants and is based on actual transactions in the overnight lending markets.
The process to replace LIBOR began in 2014 with the creation of the Alternative Reference Rates Committee, a group of industry representatives and regulators that decided in 2017 to replace LIBOR with SOFR. Since then, there has been a massive exercise to inform banks, fund managers and others about the change, prompting them to move contracts to the new rate. Starting in 2022, new deals were not to be linked to LIBOR.
But plenty of contracts written before that, and even some after, still refer to the LIBOR benchmark, and have been delayed at the last minute to meet this week’s deadline.
For example, according to JPMorgan Chase, nearly half of the $1.4 trillion debt market has switched to paying the interest linked to the SOFR. Most of the rest of the market has adopted language in loan documents that will still take loans tied to LIBOR and convert them to SOFR the following week.
“It’s a huge task,” said Meredith Coffey, who has been part of the change effort since 2017 as co-head of policy at the Loan Syndication and Trading Association. “When we started talking to people in the cash markets and told them LIBOR would be going away, they thought we were crazy.”
A small portion of the loan market — about 8 percent, or about $100 billion — has no fallback language, according to data from research firm Covenant Review. Most of those loans are by risky borrowers who have struggled to refinance their loans in terms of the SOFR.
Analysts said most of these companies could take advantage of a decision made this year by British regulators overseeing LIBOR to publish a rate that mimics LIBOR until September 2024. This zombielike rate is designed to avoid any market disruption after the time frame.
Even so, a small number of companies may be forced to use the prime rate, which reflects the cost for consumers to borrow from commercial banks – which is much higher than what banks charge each other. rate is high. Ratings agency Fitch has warned that with some borrowers already reeling from steep increases in interest rates by the Federal Reserve over the past year, a move in the prime rate could have dire consequences.
“It’s a huge change,” said Tal Reback, a director at investment firm KKR and a member of the industry committee managing the transition away from LIBOR. “It is the re-engineering of global financial markets that has come with the global pandemic, hyperinflation and rising interest rates. The pain is about to grow, but for all intents and purposes it’s time to say: ‘Rest in peace, Libor.'”
