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Changes to LIBOR (and other IBORs)

09/12/2019

LIBOR, the London Interbank Offered Rate, is being retired. It, and most other interbank offered rates (IBORs), are making way for more reliable replacements. Others are being reformed.

What is LIBOR?

LIBOR is an interest rate, or more correctly a family of interest rates, that are representative of the rates at which banks have historically been prepared to lend among themselves. They are available across a range of standardised time horizons, from overnight to 12 months ahead. Each rate is calculated based on quotes, or submissions, from a panel of banks for a number of major currencies.

LIBOR maturities

Overnight2 months
Spot/Next*3 months
1 week6 months
1 month12 months

*an overnight rate from the spot date (usually 1 or 2 days hence) to the next business day

Source: M&G, ICE, September 2019.

The coming end of LIBOR

Changes, choices and challenges

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Summary

By the end of 2021, new rates will be in place for each IBOR. Financial regulators have been closely engaged with industry working groups to identify alternative replacement reference rates.

In the UK, for example, the Sterling Overnight Index Average, also known as SONIA, has been chosen to replace Sterling LIBOR. In the US, the Secured Overnight Financing Rate, SOFR, will replace US$ LIBOR.

Purpose and timing of the changes

Regulators globally want to promote greater transparency, measurability and credibility in central-bank administered rate-setting processes, which are based on actual transactions, where possible.

They have acted because the use of interbank lending has declined substantially since the global financial crisis, which has had an effect on the reliability of some LIBOR rates. Panel banks are still providing quotes across LIBOR’s broad spectrum of rates, but the volume of transactions has fallen. Historic rate-rigging scandals also continue to weigh on LIBOR’s reputation, despite it now being subject to much stricter official oversight.

The regulators require the replacement rates to be in place by the end of 2021. The transition process is already underway, with most replacement rates already having been identified, and it is possible, or even likely, that the replacement rates will be in full effect before that current deadline.

One reason for providing a long lead time is to give parties affected by the changes sufficient time to ensure as smooth a transition as possible and to minimise the effect on all market participants. Ideally, the changes will be transparent and borrowers, lenders and investors will experience little or no effect.

We aim to provide regular updates to this information to reflect the position of the transitions as they develop.

Current solutions

Industry working groups in each market have already identified preferred replacement risk-free rates (RFRs). The main ones are:

  • UK sterling – Sterling Overnight Index Average (SONIA) replaces £ LIBOR – SONIA has existed for more than 20 years and is used in the sterling overnight indexed swaps market, and now, increasingly, as a reference interest rate for borrowing.
  • US dollars – Secured Overnight Financing Rate (SOFR) replaces US$ LIBOR – SOFR will sit alongside, and eventually replace, US$ LIBOR. SOFR is based on transactions in the Treasury repo market and has existed since 2014, though only officially published since April 2018.
  • Euro – Euro short-term rate (€STR or ESTR) and Euribor – The European Central Bank announced ESTR as the successor to the Euro overnight index average (EONIA). Currently, European authorities plan to retain a reformed version of Euribor rather than replace it.

Timeline

The agreement from panel banks to provide quotes for LIBOR expires on 31 December 2021. Some of the key milestones that have occurred to date in the development of solutions, and the transitions to them are highlighted below:

April 2018 – SONIA is reformed by the Bank of England, though it had been in use since 1997. First official publication of SOFR by the US Federal Reserve Bank of New York.

13 September 2018 – ESTR is recommended as the replacement RFR for EONIA, which will be discontinued from 3 January 2022.

2 October 2019 – ESTR is published for the first time by the ECB, reflecting transactions that took place on 1 October 2019.

Alternative rates

94B58E02B7784C85B9E2B031EA1AFDA5

Source: M&G. As at 15 November 2019

Some Frequently Asked Questions

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The information on this website is for Professional Investors only. Specifically, the information on these pages should not be used or relied upon by the public of Hong Kong or any other type of investor from any other jurisdiction.

 

The above materials and/or information is for general guidance only and should not be relied upon as, or treated as a substitute for, specific advice. Neither M&G Securities Limited nor its affiliates accept any responsibility for any reliance on any of the information contained in these materials or any direct or indirect loss which may arise therefrom. If you are in any doubt about the contents above, you should seek independent professional financial advice.