LIBOR
LIBOR
LIBOR is an acronym for the London Interbank Offered Rate. It was a benchmark interest rate that represented the average interest rate at which major global banks could borrow from one another in the London interbank market for a specified period, and in a specified currency. LIBOR was published daily for multiple currencies and various maturities by the ICE Benchmark Administration (IBA).
Calculation: LIBOR rates were determined based on submissions from a panel of major banks. Each day, these banks submitted the interest rates at which they could borrow funds from other banks in various currencies and for different maturity periods. The submissions are then averaged to calculate the LIBOR rate.
Currencies and Maturities: LIBOR rates were quoted for several major currencies, including the US dollar (USD), euro (EUR), British pound sterling (GBP), Japanese yen (JPY), and Swiss franc (CHF). Additionally, rates were published for multiple maturity periods, ranging from overnight to one year.
Importance: LIBOR was one of the most widely used benchmark interest rates globally. It served as the reference rate for trillions of dollars in financial contracts, including derivatives, loans, mortgages, and bonds.
Usage: Financial institutions used LIBOR as a reference rate when pricing various financial products. For example, variable-rate loans and mortgages often had interest rates linked to LIBOR, with the rate adjusting periodically based on changes in LIBOR.
Reform and Transition: In response to concerns about the reliability and integrity of LIBOR following manipulation scandals, global regulators initiated efforts to reform the benchmark rate. As a result, many financial markets are transitioning away from LIBOR to alternative reference rates. This transition has been a significant undertaking for the financial industry, involving adjustments to contracts, systems, and processes to accommodate the new reference rates.
Alternative reference rates, such as the Secured Overnight Financing Rate (SOFR) in the United States, the Sterling Overnight Index Average (SONIA) in the United Kingdom, and others in different jurisdictions, have been identified as replacements for LIBOR in various currency markets. These rates are derived from different methodologies, typically indicative of overnight borrowing rates in secured money markets.
The Financial Conduct Authority (FCA), which regulates LIBOR, announced in 2017 that it would no longer compel banks to submit rates for LIBOR after 2021. The decision to discontinue LIBOR was primarily driven by concerns over the lack of underlying transactions supporting the benchmark and the potential for manipulation, as evidenced by previous scandals.
The transition away from LIBOR has been a complex and multi-faceted process, requiring coordination among regulators, financial institutions, and market participants to ensure a smooth and orderly transition. While LIBOR ceased being published for most currencies at the end of 2021, legacy contracts referencing LIBOR may still exist and need to be managed or transitioned in accordance with relevant industry guidelines and best practices.
Overall, while LIBOR has historically played a crucial role in the global financial system, its usage is declining due to ongoing reforms and the transition to alternative reference rates that are considered more robust and transparent.