What is it?
Up until recently LIBOR, was the most widely used benchmark, has been used in financial products denominated in a number of currencies, and published in GBP (British Pound), USD (US Dollar), EUR (Euro), JPY (Japanese Yen) and CHF (Swiss Franc). It was calculated through a method where a group of panel banks would submit an estimate of their borrowing costs to Thomson Reuters, with the highest and lowest 25% of submissions thrown out, and the average of the remaining rates would be used to determine LIBOR rate for that day.
The Problem
Somewhere along the way motivations became skewed, with claims that the rate was being manipulated dating as far back as 1991. Panel banks began reporting lower rates in order to emulate an image of soundness in order to help fend off speculation surrounding funding difficulties during the 2008 crisis. Another motivating factor involved falsification with the intent to benefit the bank’s derivatives positions.
The Change
There was a suggestion to implement backward-looking ‘risk-free rates’, as these were said to be less susceptible to manipulation. Unfortunately it was not as simple as replacing one rate with another as there were various other scenarios that had to be kept in mind. For example, what happens to Islamic financing? Or trade and working capital financing? These were cases that had to be considered, and thus the term rate was born. The FCA maintained a strict stance on the use cases of the GBP term rate, where it was only to be used in specific circumstances, whereas the Federal Reserve Board allowed the USD Term rate to be used for any USD LIBOR use case.
What Now?
In the run up to the initial cessation date concerns were raised around tough legacy loans that would not be transitioned on time. A synthetic rate was introduced to specifically help transition tough legacy loans, but many saw it as a knight in shining armour to avoid the transition for as long as possible. Initially the synthetic rate was due to cease on the 31st December 2022 but, on the 29th of September 2022, the FCA announced the continued publication of 1- and 6- month synthetic GBP LIBOR until the end of March 2023.
The settings are due to permanently cease after this date. While there are no current plans for there to be a USD synthetic rate this is not being ruled out after June 2023.
Will this really mean the end of LIBOR for good? It remains to be seen.
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