It has been announced that the UK Financial Conduct Authority (FCA) will be phasing out the main interest rate indicator, the London Interbank Offered Rate (LIBOR), by the end of 2021. This decision was reached as the FCA deemed the indicator has become unreliable. The LIBOR is a 50 year old global borrowing benchmark based on a daily price. This price is set at 11.45am GMT by averaging submissions from a group of 20 banks of a rate that they believe they could borrow money from other banks at. This rate is then used as a standard for pricing loans, mortgages, and other financial transactions and spans five different currencies.
This is not the first time that LIBOR has made headlines, having been the subject of controversy in the past when it came to light that banks had been submitting false data in 2012. As a result several of the big banks involved in the scheme were fined around $9 billion and several bankers were convicted for manipulating the projected rates.
The decision to replace LIBOR within the next four years is predicated upon the fact that the underlying market of bank borrowing that LIBOR measures is not active enough to be a reliable measure. For one currency in one lending period in 2016 there were only 15 transactions. Andrew Bailey, widely predicted to be the Bank of England’s next governor, questioned “if an active market does not exist, how can even the best run benchmark measure it?”. As of yet no alternative has been announced, however, two measures have been suggested as potential replacements. Bailey has recommended the UK’s Sterling Overnight Index Average (SONIA) and a broad Treasury repo rate, which will reflect the cost of borrowing money secured against US government debt, as two viable benchmarks, both being strongly based in significantly active markets.
Despite the proposal of suitable alternatives there are some that believe that this transition will not be completed in the next four years with $350 trillion still in outstanding derivatives, mortgages, and loans to move to a new system. Mark Cabana, a strategist with the Bank of America Merrill Lynch, says that many banks may continue to contribute to the LIBOR rate after 2021. By this point it will no longer be necessary for banks to contribute calculations for rates in sterling, however, the LIBOR administrator, the US’s Intercontinental Exchange, may still publish the dollar rate.
Despite the disagreement over deadlines it is certain that LIBOR, following corruption and growing irrelevance, is on its way out, to be replaced by more accurate and relevant rating systems.