Clock Ticks Down Towards LIBOR's End - UK Regulator

Editorial Staff, 14 December 2021


The LIBOR system of interbank rates is ending this year, and a new regime will take over which framers hope is more liquid and, crucially, harder to manipulate. Many financial products that private banks and wealth managers use have been referenced from LIBOR.

The Financial Conduct Authority recently reminded financial markets that the way of setting market interest rates, known as LIBOR, will end and be replaced by a new system starting from January next year. 

The LIBOR system was rocked almost a decade ago by traders at banks manipulating the figures used for daily calculations of inter-bank rates, in a bid to win profits. LIBOR has been used for years to set rates for savers and borrowers, including the products employed by wealth managers. The formal LIBOR system dates back 45 years, although its origins go as far back as the 1960s.

“Tens of thousands of firms have been preparing for this, with the encouragement, support – and occasional nagging – of authorities here and overseas. We have had the common aim of minimising disruption from the retiring of a benchmark rate referenced, even at the beginning of this year, in an estimated $265 trillion of contracts,” Edwin Schooling Latter, director of markets and wholesale policy and wholesale supervision, at the FCA, said in a speech last week. 

The official said the largest slice of these contracts are in interest rate derivatives, but it also includes trillion-dollar sums of bonds and securitisations, loans, mortgages and other products.

While much of the trading and wholesale side of financial markets have prepared for the new regime – called SONIA – there have been concerns that the wealth sector is not ready for the changeover, particularly at a time when markets continue to be roiled by forces such as the pandemic. (See here and here for articles on the topic.)

The new system has been designed so that the underlying market from which rates are drawn is more liquid and harder for players to manipulate, so its framers hope. LIBOR gives the cost of borrowing for a range of different periods (one month, three months, six months, and so on); SONIA is a single rate that measures the cost of overnight borrowing. A problem with LIBOR, according to a Bank of England report in 2018, is that it is no longer liquid. LIBOR is often used to hedge the general level of interest rates, for which it is inefficient given that it includes a term bank credit component, the BoE said. 

Schooling Latter said that SONIA already dominates certain markets, showing that the system is ready to take over. In the sterling swaps market, 89 per cent of volume traded in November referenced SONIA. By end-November, cleared SONIA swaps outstanding, at 59 per cent of the total, exceeded cleared LIBOR swaps outstanding, at 41 per cent.

The commercial loans market was the last sterling market to move decisively from LIBOR to SONIA. But data collected from the banks show few cases of new use of Sterling LIBOR after end-March 2021, Schooling Latter said.

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