The arduous decade-long process of ending the financial system’s reliance on bruised interest rate benchmarks that once underpinned trillions of dollars of contracts around the world is almost over. Starting next week, the rate, known as the London Interbank Offered Rate (LIBOR for short), will no longer be published.
LIBOR is a collective term for dozens of interest rates denominated in various currencies that aim to reflect the cost of banks borrowing from each other. This rate is important because it reflects the baseline costs that banks pass on to their customers. The ups and downs of LIBOR began over 50 years ago and have been reflected in many mortgages, student loans, corporate bonds and various financial derivatives.
In 2012, Britain’s Barclays Bank became the first bank to be fined by regulators for manipulating LIBOR, which is aggregated by averaging daily quotes from a relatively small panel of banks. Submissions were purported to reflect market conditions but were not explicitly tied to actual trades, with submitters citing higher and lower rates to benefit specific trades. was accused of cheating the system. Ultimately, nearly $10 billion in fines were paid across the financial industry over LIBOR manipulation accusations, beginning an effort to move away from tainted benchmarks.
That enormous effort is about to cross the finish line this week.
“LIBOR was the ubiquitous interest rate on all financial instruments in the world. said Mark Kavanagh, head of U.S. rates strategy at . “There are still problems, but it is remarkable that LIBOR will be whispered rather than briskly launched, which would have been unthinkable many years ago.”
In the US, LIBOR has been replaced by the Secured Overnight Financing Rate (SOFR). Unlike LIBOR, SOFR represents the cost of borrowing for a wide range of market participants and is based on actual transactions in the overnight lending market.
The process of replacing LIBOR began in earnest in 2014 with the formation of the Alternative Reference Rates Committee, a group of industry representatives and regulators that decided to replace LIBOR with SOFR in 2017. Since then, large-scale exercises have been held to inform banks, fund managers and others about the transition, encouraging them to move their contracts to the new rates. From 2022, no new transactions were expected to be linked to LIBOR.
But many contracts written before that, and many after them, still cite the LIBOR benchmark, making a last-minute rush to meet this week’s deadline.
For example, according to JPMorgan Chase, about half of the $1.4 trillion loan market has switched to SOFR-fixed interest payments. Most of the remaining markets have adopted loan document language to keep loans tied to LIBOR and switch to SOFR next week.
“It was a huge amount of work,” said Meredith Coffey, who has been on the transition since 2017 as co-policy director for the Loan Syndicate Trading Association. “When we started telling people in the physical market that LIBOR was going to stop, they thought we were crazy.”
A small portion of the loan market (about 8%, or about $100 billion) has no fallback language, according to data from research firm Covenant Review. Most of those loans come from high-risk borrowers who are struggling to refinance their debt to see SOFR.
Analysts said most of these companies could take advantage of decisions made this year by the UK regulator overseeing LIBOR to publish interest rates that mimic LIBOR until September 2024. . This zombie rate is designed to avoid market chaos after expiration.
Still, a few companies may be forced to use the so-called prime rate. The prime rate reflects the cost to consumers of borrowing from commercial banks, and is much higher than the rates banks charge to each other. Some borrowers have already been hit hard by the Fed’s steep rate hikes over the past year, and the hit from the move to the prime rate could have serious consequences, ratings agency Fitch warned.
“This is a big change,” said Tal Ribak, director of investment firm KKR and member of the industry committee that will manage the transition from LIBOR. “This was the restructuring of global financial markets with a global pandemic, extreme inflation and rising interest rates. the time has come. ”
