Mar 20, 2018

The Top LIBOR Developments You Need to Know

By Liang Wu, Vice President of Financial Engineering and Head of CrossAsset Product Management, Numerix

LIBOR continues to be a substantial part of conversations in the financial world, particularly as this interest rate has been on the rise lately. But my focus here is not to write about current financial conditions—I instead wish to provide you with the most current accounting of where the LIBOR story stands today, and why early activities may suggest an orderly transition to alternative rates.

Recently, I had the opportunity to present my views on the end of LIBOR at the GARP 19th Risk Convention that was held March 6-7, 2018 in New York City. My session discussed the 2021 LIBOR decommission, including an examination of the anticipated effects on legacy contracts, curve building approaches, fallback rates and mechanisms. I also examined factors to consider as institutions shift to approaches that will replace LIBOR. Complementing my GARP presentation is a LIBOR white paper I published in early February of this year “LIBOR: Its Astonishing Ride and How to Plan for Its End.” This paper discusses LIBOR’s history, including its role in the 2008 financial crisis and the 2012 scandal, its planned phaseout by regulators, and how to prepare for its end in 2021.

Now, it cannot be said at this time that the end of LIBOR is an absolute certainty, as we must take into account that we are only at the very beginning of the transition process and that there are still many unknowns. However, recent activity by regulators, industry associations and banks suggest that the market should at least be prepared for a certain amount of discontinuity of LIBOR after 2021. There are four developments that punctuate this belief.

LIBOR’s Top 4 Developments:

1. FCA Confirms Support of LIBOR Benchmark until 2021.

On November 24, 2017, the FCA (Financial Conduct Authority, a financial regulatory body in the UK) announced that all 20 of LIBOR’s panel banks have officially agreed to support the LIBOR benchmark until the end of 2021, thus ensuring the sustainability of the rate until then. Based on this crucial support, the focus can now turn towards developing alternative rates and working towards a transition that can be smoothly executed. To market participants, this formal agreement represents a sense of stability as there is now a guarantee that not a single panel bank member will quit the panel before the end of 2021.

2. First ECB (European Central Bank) public consultation on developing a euro unsecured overnight interest rate.

This refers to the ECB calling on market participants and all other interested parties to provide comments on the ECB’s decision to publish a new unsecured overnight interest rate to replace EONIA (the euro overnight index average). The vast majority of respondents agreed with the suggested rate and it is expected that it will generally be accepted by the public as a reference rate. The rate will be finalized before 2020. This is a significant development as it further supports a smooth LIBOR transition process.

3. ISDA leads global IBOR transition with roadmap.

IBORs (Interbank Offered Rates) play a central role in financial markets and act as reference rates to hundreds of trillions of dollars in derivatives and trillions of dollars in bonds, loans, securitizations and deposits. The dependency on IBORs is changing, however, as benchmark reform initiatives are prompting a reduction on the reliance on IBORs. In fact, work is already underway to select alternate rates.

As part of this project, in late February 2018, the ISDA (International Swaps and Derivatives Association), as part of a working group made up of a number of financial market associations, has published a roadmap that provides a centralized point of reference for market participants seeking a high-level overview of the global initiatives undertaken and progress made to date for the transition from IBOR. This coordinated effort is a noteworthy milestone that provides further evidence of the very real seriousness that is being applied to an organized and well-communicated reference rate/benchmark reform process.

4. U.S. Fed to publish LIBOR alternatives April 3, 2018.

In was recently reported that the U.S. central bank has established a concrete date—April 3—to begin publishing the Secured Overnight Financing Rate (SOFR) as an alternative to LIBOR for certain new derivative and other financial contracts. The Fed will also publish other rates reflecting repo transactions: the Broad General Collateral Rate (BGCR) and the Tri-Party General Collateral Rate (TGCR).

As we can see, no time is being wasted in planning for 2021 and in solving for all the dependencies and requirements that are associated with a transition from LIBOR. In my view, all this activity means that the viability of LIBOR is quite questionable after 2021. This also sends the signal to market participants that they should consider planning for LIBOR’s potential end sooner rather than later as the impact on current derivative contracts will be very real.

To view the full presentation at the GARP 19th Risk Convention, "The End of Libor - What Happens Next?"  request the slide deck here.

Liang Wu is a Vice President of Financial Engineering and heads up CrossAsset Product Management at Numerix. Mr. Wu previously served as Director of Financial Engineering in the

Client Solution Group at Numerix. Before joining Numerix in 2015, he worked at CME Group and HSBC in pricing and valuation, and model review roles. He holds an MSc degree in Financial Engineering from Columbia University, an MSc degree in Space Physics from Rice University and a BSc degree in Geophysics from the University of Science and Technology of China.

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