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What Replaces LIBOR?

With British regulators phasing out LIBOR by 2021 in the wake of scandal, markets are scrambling to find a suitable replacement.

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What Replaces LIBOR?

What Replaces LIBOR?

The London Interbank Offered Rate (LIBOR) is considered the most important number in the world, owing to its status as the benchmark index to a range of loan products serving consumers, businesses and governments.

This reference interest rate, advisors will remember, was at the center of a scandal that involved its manipulation by traders at some of the world’s biggest banks in order to generate profits.

With British regulators phasing out LIBOR by 2021 in the wake of this scandal, markets are scrambling to find a suitable replacement.

Filling the LIBOR Vacuum

It’s a far easier task to eliminate LIBOR by regulatory authorization than it is to find a replacement that will serve the needs of lenders and borrowers alike. Nevertheless, the efforts to find an alternative lending benchmark are gradually moving forward. Here are some of the leading candidates.

  • The Federal Reserve—The Fed has created the Secured Overnight Financing Rate (SOFR), a rate arrived at by producing the weighted interest rate average of overnight repo lending between banks. Though market adoption of SOFR has been very slow, it should help that the CME Group is expected to launch SOFR futures in May, assuming regulatory approval.
  • Private Sector—The developer of the first interest rate futures contract in the 1970s, Richard Sandor, has developed his own, market-tested alternative. Sandor founded the American Financial Exchange in 2015 where members—mostly small- to mid-size banks—can meet their short-term, interbank funding needs, and from which a benchmark overnight interest rate—the Ameribor—is derived.
  • International Markets—Other developed nations are also looking to create LIBOR alternatives. Great Britain is considering a Reformed Sterling Overnight Index Average (SONIA), which will initially be administered by the Wholesale Markets Brokers’ Association, but eventually transitioned to the Bank of England. Switzerland and Japan also have alternatives under consideration, while the ECB established a working group to explore developing its own overnight rate index.

Relevance to Your Clients

Most Americans haven’t even a rudimentarily understanding of LIBOR, though many recognize that their mortgage rate may be tied to the LIBOR rate. According to an estimate by Oliver Wyman, the consultancy, approximately 300,000 retail customers have loans tied to LIBOR.1

This may mean that sometime in the near future your clients will be getting calls from their banks to explain the transition to a new benchmark rate for their mortgages and other loans. Whether banks will need customer approval to change the benchmark for outstanding loans tied to LIBOR, at the moment, is unclear. Stay tuned.

Source:

  1. https://www.oliverwyman.com/content/dam/oliver-wyman/v2/publications/2018/February/LIBOR-transition-POV-FINAL.pdf

See referenced disclosure (2), (3) and (4) at http://blog.americanportfolios.com/disclosures/ 

About The Author

Cliff Walsh, CFA

 

Vice President of Asset Management 
631.439.4600 ext. 277 

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