Wednesday, June 21, 2017

Does LIBOR Have a Future?

Committee Meets this Week to Discuss Alternative Benchmark Rates

The London Interbank Offered Rate (LIBOR) has been the primary short-term reference interest rate for nearly fifty years. Following a scandal wherein employees of rate-setting banks were implicated in manipulating LIBOR, U.S., European, and other regulators embarked on efforts to reform or replace the benchmark rate. At its height, LIBOR was the global benchmark interest rate for an estimated $300 trillion in derivatives, loans, and mortgages. Despite efforts by market participants to move away from LIBOR and regulatory efforts, including widespread money market reforms limiting its use, the benchmarks rate remains entrenched in the global financial system. For several years, the future of LIBOR has been clouded. However, Reuters reported on June 20, 2017 that “a committee of global banks will vote on Thursday (June 22) on an alternative to [LIBOR] for use as a benchmark U.S. interest rate for derivatives contracts,” potentially providing more clarity as to LIBOR’s future or its replacement. 


In 2013, the Wheatley Review of LIBOR, a UK government-commissioned report, proposed that in the immediate term “LIBOR should be reformed, rather than replaced.” Following this report, LIBOR quotations were discontinued for certain currencies and certain maturities, and the British Bankers’ Association was replaced as the LIBOR rate-setting body by ICE Benchmark Administration. In contrast, in the U.S., regulators called for reliance on LIBOR to be discontinued entirely and for the establishment of a new benchmark rate or multiple rates.  The Federal Reserve and U.S. Treasury then set up the Alternative Reference Rates Committee (ARRC) to seek an alternative to LIBOR.[1] The mission of the ARRC was to develop an alternative rate not only useful as a reference rate for derivatives but also for cash fixed-income investments like floating rate securities. ARRC was also asked to devise an orderly transition strategy to the new rate. 


Amid this difference of opinion amongst global regulators, ICE Benchmark Administration remains dedicated to reviving and maintaining LIBOR’s hegemony. The organization began by reforming the calculation methodology, independent governance, and transparency. While these efforts have had some measure in reviving confidence in LIBOR, many are still looking to the ARRC for alternatives. ARRC considered half a dozen different potential LIBOR alternatives, but in 2016 [2] proposed two:


  1. A rate based on the overnight unsecured bank borrowing market. (the Overnight Bank Funding Rate (OBFR)—based on data from over 150 banks active in the United States); and
  2. A rate based on the overnight secured Treasury general collateral repurchase agreement rate (the GC repo rate). 


The Fed has indicated that the selection of an alternative reference rate (or rates) to LIBOR would take place sometime in 2017.[3]  The ARRC meeting on June 22 is poised to do just that, potentially setting the stage for the eventual demise of the once mighty LIBOR. 



[1] Voting members of the ARRC include US and non-US banks; non-voting members include the International Swap and Derivatives Association, Inc.


[2] Alternative Reference Rates Committee (2016), Interim Report and Consultation (New York: ARRC, May),


[3] In an open session on November 16, Federal Reserve Governor Jerome Powell briefed the Financial Stability Oversight Council on LIBOR alternatives. He said he expected the selection of an alternative reference rate in 2017, but the transition to a new rate will require broad market acceptance. That transition may be challenging because LIBOR is so widely used. Effective planning and collaboration between industry and government will be critical to making the transition smoother and faster.