Finally, Libor's on the way out ..... and it's not just the scandals that are killing it. r

Even those for whom Libor has been a significant factor during their working lives must be thinking "Not before time ..... !" . The UK's Financial Conduct Authority has set a 2021 deadline to find an alternative to the benchmark rate upon which so many financial instruments are priced. Since inception in the mid-1980s Libor has performed a crucial and efficient role in global markets ..... or at least that's how it seemed until the rate-rigging scandal erupted six years ago.

First, some background :

Each day, a panel of leading banks in London are contacted (at about 11.00am) to discover what they believe to be the true rate at which they could borrow from one another . The average of their responses is designated the London InterBank Offered Rate -- or Libor. The process is applied for five different currencies , across seven different maturities from overnight to one year -- giving a total of 35 separate Libor rates.

The reason that Libor -- and any move away from it -- is such a big deal is that worldwide, at its peak, about $350tn worth (yes, that's $350 trillion) of financial products were priced against Libor. Any instrument with a floating rate of interest such as mortgages, loans, floating rate bonds or derivatives can carry an interest rate or coupon which is regularly reset at an agreed premium over (or theoretically discount to) Libor. What you pay in interest on a mortgage for example might be readjusted each year to a rate that was the 1 year Libor rate PLUS 2.00%, say. You can see why Libor is not just a crusty financial concept of concern only to those in the financial services industry ...... and why the rigging of the official Libor rates has been so hugely damaging.

Leaving aside the cringe-worthy, laddish excesses of some of the individuals involved, a variety of banks have been fined a total of about $9bn (so far) for skewing Libor rates in the direction that suited their trading books at the time. Others were guilty of seeking to distort the Libor rate to make themselves appear stronger during the financial crises when lower borrowing rates were viewed as a sign of strength. Such abuses came as a foul-tasting revelation to a general public who already held the banking industry in pretty low esteem, and perhaps it's surprising that the Libor system continues to this day.

As it happens however, the final straw that has forced the FCA to find an alternative by 2021 is less about the scandals of the recent past, and much more to do with the fact that the interbank lending market upon which Libor is based has dried up since the financial crisis. As FCA boss Andrew Bailey says : "If an active market does not exist, how can even the best run (i.e. clean !) benchmark measure it ? Moreover, panel banks feel understandable discomfort about providing submissions based on judgments with so little borrowing activity against which to validate those judgments." Well, we can see how they might.

When a US regulator , Gary Gensler, called Libor "unsustainable" back in 2013, the British authorities disagreed largely on the grounds that it would be nigh impossible to replace. Presumably they feel differently now, and have got over their concerns about existing Libor-based contracts that mature after its demise, believing in those cases that counterparties will be agreeable to applying Libor's replacement .

Which will be what, exactly ? The FCA plumped for a reformed version of Sonia -- the Sterling overnight index average -- back in April, but has only just put a time frame on it. The Bank of England will collect information on actual lending deals between banks (and those arranged by brokers) for sums in excess of £25m, and derive a reference rate from that information.

That would certainly have the great benefit of being based on real transactions, rather than an estimate offered by an individual dealer who may not have been involved in that particular market for some time (comparatively speaking). We'll have to wait to see how well it will work across the maturity range, and even more fundamentally how well it will fit with systems adopted by other regulators. The US authorities, just as one hugely important example, have gone for a reference rate based on transactions in the Treasury repo rate.

*** You remember repos -- or sale and repurchase agreements ? A would-be borrower sells an asset (e.g. a Treasury bond) to another party, with an agreement to buy it back later at a higher price. The difference in price represents the effective interest rate.***

The FCA's decision to implement a new system by a certain date does force all involved to ready themselves, but at the same time a date as far out as 2021 reflects the complicated processes that will need to be undertaken. Sure, this may seem like dry and uninspiring stuff but it will probably have more direct effect on the man and woman in the street than many of the more exciting stories we look at.

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