The potential demise of LIBOR hit the headlines in July when the CEO of the UK’s Financial Conduct Authority (FCA) announced that the rate is no longer tenable (based on a lack of transaction based data) and that the FCA will withdraw support for LIBOR by the end of 2021. He also stressed that work must begin to plan a transition from LIBOR to alternative reference rates by such time.
His statement wasn’t a new view among regulators. Since a report by the Financial Stability Board (FSB) in 2014, IBOR administrators have been following the FSB’s recommendations to strengthen existing benchmarks for key IBORs (including LIBOR and EURIBOR), while market participants have been developing fall-backs in the event that LIBOR becomes unavailable, and working on the development of alternative risk-free reference rates (RFRs).
By putting a 2021 date on the potential demise of LIBOR, however, the development of RFRs has become more pressing.
What is the problem with LIBOR?
Following a number of scandals involving the setting of LIBOR, the benchmark is seen as lacking credibility. This has been exacerbated by the criminalisation of benchmark manipulation and the introduction of the EU Benchmark Regulation1. The EU Regulation imposes obligations on the administrators, and on the contributors of data into indices used as market benchmarks. This has discouraged banks from inputting into rate based indices because of the compliance burden and the risk of sanctions (LIBOR related manipulations have so far been subject to fines of around US$9 billion ).