Libor, the nearly 50-year-old global borrowing benchmark that became a byword for corruption, is headed for the trash heap of history.
The U.K. Financial Conduct Authority will phase out the key interest-rate indicator by the end of 2021 after it became clear there wasn’t enough meaningful data to sustain the benchmark that underpins more than $350 trillion in securities, Andrew Bailey, the head of the regulator, said in a speech Thursday at Bloomberg’s London office.
In addition to serving as a benchmark for fixed-income securities, Libor is a benchmark embedded in crediting rate provisions and other provisions for many annuity contracts and life insurance policies, and it also affects the derivatives and other arrangements used to support some life and annuity product guarantees.
The end of the London interbank offered rate, or Libor, is welcome on many levels for regulators. It was tied to some of the banking industry’s biggest scandals, leading to about $9 billion in fines and the conviction of several bankers for manipulating the rate. Relying on the opinions of industry insiders to set the daily estimates based on interbank lending — some in markets that saw fewer than 20 transactions annually — was unacceptable, Bailey said.
“Libor is trying to do too many things: it’s trying to be a measure of bank risk and it’s trying to substitute for interest-rate risk markets where really it would be better to use a risk-free rate,” said Bailey in an interview with Bloomberg News before the speech. “It’s had to come to a conclusion.”
Bailey said setting a firm schedule will help banks and finance companies manage the transition from Libor, which is behind securities including student loans and mortgages.
The benchmark is the average rate a group of 20 banks estimate they’d be able to borrow funds from each other in five different currencies across seven time periods, submitted by a panel of lenders every morning. Its administration was overhauled in the wake of the scandal, with Intercontinental Exchange Inc. taking over from the then-named British Bankers’ Association with the aim of making the rate more transaction-based.
But the 58-year-old Bailey said the market supporting Libor — where banks provide each other with unsecured lending — was no longer “sufficiently active” to determine a reliable rate and alternatives must be found. For one currency and lending period there were only 15 transactions in 2016, he said.
“The absence of active underlying markets raises a serious question about the sustainability of the Libor benchmarks,” said Bailey, who is widely seen as a candidate to be the next governor of the Bank of England. “If an active market does not exist, how can even the best run benchmark measure it?”
The search for a new benchmark may lead to tighter swap markets, lower rates and richer attorneys as contracts need to be rewritten and adjusted to remove Libor.