The future shape of the market without Libor has sowed just as many seeds of uncertainty. A number of alternative benchmark rates are contenders to succeed, but both corporates and banks want greater clarity from the regulator.
Rather like an elderly celebrity, who you assume has died but is simply no longer in the public gaze, Libor lives on. But it looks as though its days are numbered.
And not unlike several individuals who fell from grace, Libor’s long career foundered among accusations of misconduct. A series of high-profile cases and fines revealed how widely the benchmark London Inter-bank Offered Rate had been manipulated by traders at various financial institutions.
Until early 2014 the rate was administered by the British Banker’s Association (BBA) and was known as BBA Libor. The Intercontinental Exchange Benchmark Administration Limited (IBA) then took over the role, changing the name to the ICE Libor.
However, while Libor has apparently cleaned up its act its future is uncertain. “Libor was originally created for the loans market where it was fit for purpose, but once it moved into the interbank derivatives market, lack of volume meant it was no longer sufficiently robust,” says Sarah Boyce, associate policy and technical director for the Association of Corporate Treasurers (ACT).“So regardless of the various manipulation scandals, it needed to be revised.”
The Financial Conduct Authority (FCA) and the Bank of England (BoE) have deemed that Libor is no longer up to the job – a conclusion shared by the Financial Stability Board (FSB) set up by the G20, which back in 2014 recommended the introduction of alternatives.
Four years on the ICE Benchmark Association (IBA) is working on reforms of Libor, but over the past year FCA chief executive Andrew Bailey has been speaking publicly of the “transition to a world without Libor” in which it is supplanted by various interest rate benchmarks.
So while the ACT and Loan Market Association (LMA) issued a joint guide in March ‘The future of Libor – what you need to know’, the title may be a misnomer. In a keynote speech two months ago Bailey hammered home his message, stating “I hope it is already clear that the discontinuation of Libor should not be considered a remote probability ‘black swan’ event. Firms should treat it is as something that will happen and which they must be prepared for.”
“From the banks’ perspective the manipulation scandals meant the reputational risk of contributing to the panel became enormous,” says Boyce. “but rather than have Libor fall off a cliff – with the associated market disruption that would cause – the FCA have worked with existing panel banks to enable a smooth transition, persuading the banks to continue to contribute data until the end of 2021.
Candidates for succession
The big – and still unanswered – question then arises of which benchmark rates should succeed Libor. “This has been approached on a currency-by-currency basis which has led to some inconsistencies but all are based on near risk pre-rates (as recommended by the FSB), an overnight and backward-looking rate being published the following day,” says Boyce.
Candidates include the US Libor alternative, the Secured Overnight Financing Rate (SOFR), Lord of the Rings soundalike SARON (Swiss Average Rate Overnight), the Tokyo Overnight Average (TONA) and the Bank of England-administered Sterling Overnight Index Average (SONIA). While Sonia has been used for years, since the BoE took over running it last April it has supported around 370 transactions per day on average, against 80 previously.
However, no single benchmark is likely to succeed Libor, which raises a raft of questions such as the treatment to be afforded, for example, to multicurrency revolving credit facilities (RCFs).
“Working groups have been set up in various jurisdictions and include representatives from the private sector, who are working to determine what the market of the future should look like,” says Boyce. “However, neither banks nor corporates are really in a position to come up with all the answers and both are waiting – or hoping – for the regulator to point to the way forward.
“The FSB has stated that term rates need to be developed so certain parts of the market are prepared ahead of 1st January 2022. Another big unanswered question is about legacy transactions and how those referencing Libor still in place at that date will be treated – this also applies to deals maturing over the interim period and those now being made which won’t mature until post-2021.
“So much work and discussion is taking place on how to fix the problem. The International Swaps and Derivatives Association (ISDA) has initiated a consultation on how fallbacks might work for the derivatives market.”
Uncertainty over the future, parallels that surrounding Brexit. Devising solutions promises to be an equally complicated process. Indeed, Boyce believes the repercussions could potentially be greater and urges corporate treasurers to start discussing the various issues with their bank.
Among these is inter-company funding priced off Libor. If the benchmark disappears and something else takes its place, tax authorities must start scrutinising this type of funding more closely. Accounting could be forced to re-open loan and derivative books.
“People are waiting for the financial markets to become more liquid and for products they can use to emerge,” says Boyce. “More sophisticated corporates already recognise the potential problems and want to address them, but the banks don’t yet have available products that they can use. The sooner you can use the new regime for loans the better; unfortunately no bank wants to be the first to move.”
There have been calls for collaborative efforts to resolve the problem, which Boyce believes would have been more easily accomplished 20 or 30 years ago. “Working together is now easier said than done, when competition law rules and nervousness about anything that could potentially be regarded as market collusion mitigate against progress. There needs to be more flexibility – the clock is ticking and the pace of change, particularly in the form of new products, needs to pick up speed.”