The end of LIBOR

What is LIBOR?
LIBOR (London interbank offered rate), as its name suggests, refers to the reference rates of the English money market. Equivalent Anglo-Saxon of EURIBOR, it is calculated for several different terms and in 5 currencies. Published on a daily basis, it is calculated from a panel of banks set up by the ICE BENCHMARK ADMINISTRATION.

The history of LIBOR began in the 1990s, when market participants reported an increased need for a rate benchmark. It was under the direction of the British Banker’s Association that the first LIBOR rates were published in 1986.

How is LIBOR calculated?
LIBOR rates are calculated daily, not on the basis of the latest transactions carried out but by the rate announced by each of the banks in the panel. This announced rate is the one she believes she can obtain, at this time, for this term and currency for a loan on the interbank market. After receiving the data, it is calculated by performing a discretionary average. That is, the highest and lowest 25% rates should be rejected from the panel. LIBOR is then calculated on the remaining data, which are considered the most honest in the panel.

The importance in economic life
LIBOR rates, in addition to their vital importance in the English banking system (the majority of real estate loans in England are variable rate) also have a huge impact on the financial markets. The 1, 2 and 3 month maturities are widely used as the reference rate for SWAP and eurodollar products due to the importance of the London financial centre.

But even before the scandal of its manipulation, LIBOR had begun to show its limits. During the 2008 crisis, the spread between the rates announced by each of the banks in the panel had exploded.

LIBOR handling
As we have seen, LIBOR rates are calculated using the estimate made by each of the banks. As a result, the risk of rate manipulation seems possible given that the world of market finance is a restricted environment. It was in 2011 that the scandal broke. Today we know that the majority of the banks included in the panel were all involved. Among the most important are the following: Barclays, UBS, CREDIT SUISSE, Bank of America, Citigroup… The affair was resounding and many Traders were judged by the English and American courts. Moreover, the various manipulations took place at the employees’ workstations. The fact that their exchanges were exclusively by email or discussion via forum shows that these manipulations were known to everyone and could be visible to everyone.

The end and replacement of LIBOR
It was in the summer of 2017 that the British Financial Markets Regulator (FCA) announced the abolition of the LIBOR rate by 2021. This is due not only to the history of rate manipulation but also, according to the British gendarme, to the fact that the market for keeping LIBOR alive is no longer active enough.

The debate on the future rate to replace LIBOR is not yet over. It now seems that in the long term, it will be the SONIA (Sterling Over Night Index Average) and its calculation method that is currently favoured by the Central Bank of England. That being said, the shortage of transactions on this market and the BREXIT risk in the long term to remove their specific reference rate characteristics from derivative contracts.

Benoit LECOUTRE


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