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Replacement of LIBOR

All information about the replacement of LIBOR

Interbank offered rates (IBORs) play a key role in the financial markets, serving as reference interest rates for derivatives and loans, for example. These reference rates – which include the London Inter-bank Offered Rate (LIBOR) and the Euro Interbank Offered Rate (Euribor) – are currently the subject of reforms.
Background

One reason for replacing the LIBOR is to be found in the 2008 financial crisis. Since that time, banks have extended credit only to clients who can provide collateral. Consequently, for many maturities no actual transactions are concluded anymore and the prices given are only estimates. That means the IBORs have lost their information value and are no longer suitable as reference rates. Another reason for replacing the LIBOR was the discovery in 2012 of attempts to manipulate the market.

In the wake of that discovery, in 2013 the G20 (the world’s 20 largest industrialised and emerging-market economies) asked the Financial Stability Board (FSB) – an international organisation entrusted with oversight of the global financial system – to conduct a thorough review of the key reference rates. As a consequence of the review, the British Financial Conduct Authority (FCA), which is responsible for oversight of the LIBOR, announced in 2017 that LIBOR fixing would be discontinued as from 2022.

Impact on financial service providers

After this announcement, global regulators advised financial service providers to cease using the LIBOR as a reference rate as from 2022 and to utilise other IBORs instead. Going forward, the contracts and products in question were to be based on new, more robust, reference rates. Replacement of the LIBOR has a substantial impact on processes and technical aspects. In every currency area, working groups were set up per currency to develop alternative reference rates (ARRs) and to manage the transition to these rates.

As a rule, ARRs are provided by official institutions such as central banks or stock exchanges, and thus offer little scope for manipulation. ARRs are daily interest rates with little or no credit risk. What is more, the markets on which ARRs are based are considerably more active than those underlying the IBORs. Whereas the IBORs are based to a large extent on the opinions of experts, ARRs are based on transactions effectively carried out.

Examples of alternative reference rates

Currency

Alternative reference rate

CHF

Swiss Average Rate Overnight (SARON)

EUR

Euro Short-Term Rate (€STER)

USD

Secured Overnight Financing Rate (SOFR)

GBP

Reformed Sterling Overnight Index Average (SONIA)

JPY

Tokyo Overnight Average Rate (TONAR)

SGD

Singapore Overnight Rate Average (SORA)
Evolution/milestones of the IBOR replacement process
Infographic
Impact on VP Bank clients

The changeover had direct consequences, for instance, for credit products with interest rates that are fixed for up to one year. CHF-denominated loans were the first products to be converted: starting January 2021, the SARON replaced the LIBOR as the new reference rate for the first converted products. In the course of 2021, the reference rates for further currencies were gradually replaced with ARRs. In USD, the LIBOR for the most important terms was published longer than initially planned, namely until June 30, 2023.