Daily Management Review

Is there a worthy alternative to LIBOR?


London Interbank Offered Rate (LIBOR) is published each working day shortly before noon on British time. This is the weighted average rate at which loans are offered to banks in five currencies and seven maturities, from one day to 12 months. The rate is based on the data provided by 20 selected banks.

LIBOR underlies financial contracts for more than $ 350 trillion. Derivatives depend on it the most. However, many other financial products, including corporate loans and mortgages, also use LIBOR or similar rates, in particular EURIBOR (interbank rate for the euro).

However, the days of LIBOR seem to be numbered. Regulators are actively promoting other benchmarks. July 27, Head of the Financial Supervisory Authority of Britain (FCA) Andrew Bailey said that his agency had agreed with banks to use LIBOR only until the end of 2021

In April, a working group set up by the Bank of England concluded that SONIA (Sterling Overnight Interbank Average Rate), administered by the Central Bank, is the preferred alternative.

In June, a committee convened by the Federal Reserve proposed a broad reverse purchase of securities or a repo rate as a replacement for the dollar LIBOR.

Competing rates also exist in Japan and Switzerland, the British magazine The Economist notes.

Outside of the financial world, LIBOR is more known for its high-profile scandals: in 2012 it became clear that banks had manipulated the information about the cost of borrowing for many years.

In 2015 and 2016, five traders received a prison sentence for a criminal conspiracy.

LIBOR has not even been regulated until 2013, when the Financial Supervision Authority of Great Britain began to monitor this market. In 2014, the ICE Benchmark Administration (IBA), a subsidiary of the Intercontinental Exchange (which owns a number of stock exchanges, including the NYSE), began managing LIBOR.

According to IBA’s Head Finbarr Hutcheson, the rate is controlled by a "very clever computer program." Banks and regulators have also strengthened their supervision.

However, the desire of regulators to move to alternative benchmarks is more motivated by technical than moral anxiety.

The market supporting LIBOR, where banks provide unsecured loans to each other, is already "not sufficiently active" to determine a reliable rate.

According to Bailey, banks setting the LIBOR rate for one of the benchmark versions made only 15 transactions in that currency during the entire 2016 in one case. Something close to the risk-free rate would be the best benchmark for some markets, primarily for derivatives.

That is why various institutions are showing special interest in alternatives (SONIA or the US broad REPO rate), which are based on transactions. Such benchmarks are much more difficult to manipulate, and they are more resistant to fraud, which cannot be said about LIBOR.

However, alternative rates also have drawbacks. Joshua Roberts, an expert at JCRA consulting firm, agrees that LIBOR is likely to be replaced by a transaction-based rate.

Yet, he points out that SONIA (set daily a one-day interest rate), for example, does not reflect the dependence of the rate on the loan’s terms. A borrower, tied to a three-month LIBOR, knows its interest payments for the next quarter. This will not be possible with SONIA.

Perhaps it’s too soon to completely write off LIBOR. Finbarr Hutcheson welcomes the competition, but, in his opinion, LIBOR still suits many, including transnational corporate borrowers. "I'm absolutely sure," he says, "that LIBOR will stay with us for a very, very long time."

source: economist.com

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