The London Inter-Bank Offered Rate (LIBOR) is the most widely used interest rate across financial markets. It is used to set rates for government and corporate bonds, mortgages, student loans and credit cards, as well as derivatives such as interest swaps and futures. It is calculated as an average by a panel of contributing banks, based on how much it would cost them to borrow from each other.
In 2012, it was discovered that some banks were manipulating LIBOR for their own advantage. The resulting scandal led to billions in fines and calls for a number of actions - including reform of the benchmark, mandatory audit of submissions (which ICAEW created the guidance for in 2014) and a new regulatory regime.
The interbank lending market looks very different today. Banks are now safer and rely far more on customers deposits than borrowing from other banks. This means that the vast majority of interbank lending is now in the overnight market, with little activity at longer maturities. If there are no longer sufficient transactions to support LIBOR submissions that creates a problem.
In response to this, the FCA (Financial Conduct Authority) confirmed in July 2017 that it will no longer ask banks to voluntarily submit data to the LIBOR after 2021. This has been perceived by some as an indication of the timeline for replacing the LIBOR benchmark.
Given the extent to which LIBOR is used across markets and embedded within institutions’ internal processes, systems and controls, the impact of transitioning from it will be significant.
There are trillions of dollars of LIBOR-related transactions that will not mature before 2022. Any firm that has direct (loans) or derivative positions that reference LIBOR will need to consider the effect of this change on their risk management, their legal and compliance teams, and on their technology and operations. The need for a plan to facilitate an orderly transition should not be underestimated.
I want to emphasise to members that this is more than just a technicality; significant work will be needed, and at a time when many businesses are already under pressure with accounting changes, Brexit planning and other regulatory-driven projects.
ICAEW’s Financial Services Faculty has recently published a helpsheet to provide advice and guidance on where to start.
If you require further assistance or have specific questions, you can contact the Faculty directly at email@example.com.