The tainted suite of interest rates known as the London Interbank Offered Rates is scheduled to be phased out by the end of 2021. But the benchmark for global borrowing costs is proving tricky to replace. It’s time for the regulators to rethink killing off what was once dubbed “the world’s most important number” until the rigging scandals besmirched Libor’s reputation.
The main markets have nominated their official successors to Libor. In dollars, the chosen benchmark is the Secured Overnight Financing Rate. For U.K. markets, it’s the Sterling Overnight Interbank Average Rate. And in the euro zone, the European Central Bank’s forthcoming Euro Short-Term Rate was selected.
But the resulting alphabet spaghetti has proved unpalatable, with SOFR and SONIA struggling to gain traction. Of the $54 trillion of interest-rate derivatives traded in the third quarter, just 3.3 percent were tied to Libor alternatives, according to the International Swaps and Derivatives Association.
In November, the Bank of England calculated that the share of the notional cleared sterling swap market that uses Sonia as its reference rate was 18 percent, up from 11 percent in July 2017. That’s a pathetic growth rate, particularly given that the benchmark, which is based on overnight transactions in the wholesale market with a minimum value of 25 million pounds ($31.7 million), has been in existence since 1997. The Financial Conduct Authority has been bludgeoning banks since the middle of the year to make the transition. Inertia is hampering its efforts.
Earlier this month, the European Parliament backed the finance industry’s calls for a two-year reprieve for the existing euro benchmarks, Euribor and Eonia, until the end of 2021. About 22 trillion euros ($25 trillion) of derivative contracts are tied to Eonia; the ECB doesn’t plan to start publishing its new rate until October, which made the original deadline of the end of 2019 somewhat unfeasible.
FCA Chief Executive Officer Andrew Bailey, one of the chief architects of the benchmark revolution, estimates that about a third of the $170 trillion of swap contracts that still rely on Libor for their prices won’t mature until after the benchmark is scheduled to perish. More than $500 billion of bonds that reference Libor will still exist after the benchmark rates are scheduled to end, the Financial Times reported in October, citing figures compiled by the Linklaters law firm.
Those intimately affected by the coming changeover are worried. In November, Goldman Sachs Group Inc. Treasurer Beth Hammack said shifting to new benchmarks would be “a really painful transition” in part because “markets are really creatures of habit.” The U.S. Government Finance Officers Association said in September that ousting Libor poses risks to about $44 billion of floating-rate municipal bonds issued by states and cities.