As per details, LIBOR is a collective term for dozens of rates which is denominated in different currencies and intended to reflect how much it costs banks to borrow from one another.
Starting more than 50 years ago, LIBOR — which reflects the baseline cost that banks pass on to customers — its ups and downs have been reflected in many mortgages, student loans, corporate bonds, and a wide variety of financial derivatives, starting more than 50 years ago.
Barclays in 2012 became the first of many to be fined by regulators for manipulating LIBOR. Initially, it was compiled by taking an average of the rates quoted by a relatively small panel of banks each day.
Though the submissions were supposed to reflect market conditions, the submitters were accused of gaming the system by quoting higher or lower rates to benefit specific trades as they were not expressly linked to actual trading.
Following accusations of LIBOR rigging, almost $10 billion in fines were meted out across the financial industry. Meanwhile, that effort is crossing the finish line this week.
“LIBOR was a ubiquitous rate across all global financial products; it was the single most important benchmark in the world, and to move the market away from that has been a truly herculean effort,” NYT quoted the head of US rates strategy at Bank of America Mark Cabana as saying.
“There are still issues, but, remarkably, LIBOR will go out with more of a whimper than a bang. That was unthinkable years ago,” Cabana added.
Unlike in Europe, the United States is replacing LIBOR with the Secured Overnight Financing Rate, or SOFR, which represents the cost of borrowing for a broader variety of market participants. Also, it is based on actual transactions in overnight lending markets.
In 2014, the US began the process to replace LIBOR but succeeded when the regulators in 2017 decided to replace LIBOR with SOFR.
After this only, the process for transition to inform banks, fund managers, and others was underway, pushing them to shift contracts over to the new rate. So from 2022, new deals were not supposed to be linked to LIBOR, added the report.
However, there are multiple contracts written before then, and after that still cite the LIBOR benchmark.
According to JPMorgan Chase, around half the $1.4 trillion loan market, for example, has switched to paying interest pegged to SOFR. While the rest of the market has adopted language in loan documents that will take loans still tied to LIBOR and switch them to SOFR next week.
As per co-head of policy at the Loan Syndications and Trading Association Meredith Coffey, who has been part of the transition effort since 2017, “It’s been a gargantuan amount of work.”
Coffey said, “When we started talking to people in cash markets telling them that LIBOR would cease, they thought we were crazy.”
Other data from the research firm Covenant Review says roughly 8 percent, or around $100 billion of the loan market has no fallback language.
It adds that the loans are taken by riskier borrowers who struggled to refinance their debt to reference SOFR.
According to analysts, companies may take advantage of a decision made this year by British regulators to publish a rate that mimics LIBOR through September 2024. The high rate is designed in a way to avoid any market disruptions after the deadline.
Considering this also, a small number of companies may opt for the prime rate — the cost for consumers to borrow from commercial banks — which is a much higher rate than what banks charge one another.
Ratings agency Fitch has warned that moving to the prime rate could have severe consequences as borrowers already buckling under the drastic increase in interest rates by the Federal Reserve since 2022.
Director at the investment firm KKR – Tal Reback, who is also a member of the industry committee managing the transition away from LIBOR opined that this has been a colossal change.
“It’s been a re-engineering of global financial markets that came alongside a global pandemic, extreme inflation, and rising interest rates. There are going to be growing pains, but it’s time to say: ‘Rest in peace, LIBOR’,” he said.
Updated: 01 Jul 2023, 04:31 AM IST