LIBOR Transition: Being Forewarned is Forearmed
Authored by Sharon Freeman, Managing Director, Antevorta Consultants Limited
The LIBOR Transition Backdrop
The financial crisis of 2007-2008 saw casualties across both the real economy and the financial economy. The ensuing months saw consumer confidence in the financial industry hit a historic low. It was not surprising that regulators1 and standards-setting bodies2 around the world responded quickly to restore confidence and build stability. Extensive regulatory reforms and standards were swiftly conscripted aimed at the financial industry by tightening the rules and reporting requirements in which the financial, insurance and pension industries operate.
Dodd-Frank3, Basel III4, Solvency II5, EMIR6, MiFID7, BCBS-IOSCO8 and their risk reduction initiatives (Volcker Rule, QFC, Ring-fencing, CCP, FRTB, UMR, SM&CR, etc) are just some of the regulatory reforms and standards that have fundamentally altered the financial ecosystem we see today.
The most widespread regulatory change directly affecting a broader range of industries and consumers are applied to financial benchmarks. These regulatory reforms address the accuracy, methodology, and integrity for various benchmarks including the interbank offered rates (IBOR).
LIBOR, the London Interbank Offered Rate, is the most extensively used interest rate benchmark throughout the world. It is based on transactions where creditworthy banks would lend money to each other at a certain rate, for a particular currency (USD, GBP, EUR, CHF, JPY) borrowed over a specific period of time. (USD is the most referenced currency for periods of 1 month, 3 months and 6 months.)
LIBOR’s usage is vast, buried deep in documentation ranging from student loans to complex derivatives to structured lending facilities to tax-efficient vehicles (ETF, UCIT, REIT, etc) as well as entwined in risk models, restructuring defaulted loans, discount rate formula, fee arrangements, threshold triggers, hedge fund performance measures, to name a few.
During the financial crisis, the scandal of rate-rigging for LIBOR first emerged. This scandal instigated a series of benchmark reforms; the FSB’s report on Reforming Major Interest Rate Benchmarks9, the IOSCO Benchmark Principles10 and the EU Benchmarks Regulation11.