The number that might disappear

Nowadays there are more and more rumors about the disappearing of the LIBOR. The London Interbank Offered Rate (LIBOR) is posted on a daily basis and is used for a benchmark for almost all the contracts with floating interest rate. The importance of that number is so great that transactions and contracts for billions of dollars entirely depend on it. However, according to the New York Times after a discussion on a global meeting in New York this month all of that might be changed in 2021. That’s why in this article I will give my best to explain what could be the consequences of such a type of decision and what deviations might appear from an economic point of view.

At the meeting that I mentioned earlier, the major regulators created concerted pressure with appealing to the banks and the dealers to start their transition to operate without the LIBOR. The idea behind all of that is to begin usage of the contracts which will be analog of the LIBOR after 2021. This should make the transition process easier from a managerial point of view. Moreover, this is needed because even though everything for the change is going on schedule, according to the CEO of the Financial Supervision Commission in the UK the whole process tempo is still not fast enough. Furthermore, regulators which are represented by Federal Reserve and the England Central Bank are suggesting that the new reference interest rate should be pursuant with more active and liquid markets.

At the same meeting, the international association for swaps and derivatives announced that they are starting to consult market participants according to the plan of the transition period. This organization is developing fiscal rates which can be used as a substitute mechanism for the contracts that are using LIBOR.

The LIBOR itself is defined by collecting data from several big banks of what interest rate they will pay if take a loan from another bank. The highest and the lowest number are excluded, and the average number from the rest is the LIBOR. Just for your information on a global scale in 2016, there were contracts for 190 billion dollars based on LIBOR. Unfortunately, there was evidence that the LIBOR has been manipulated in the past which is one of the reasons why the financial regulators require its exclusion.

The problem here appears when it was discovered that the sample of interviewed institutions is relatively small. In this way, some bankers working as a cartel could influence the number by agreeing on the data between them. In this way, they can reduce their risk. This topic became very debated after the LIBOR scandal in 2011 where several banks were forced to pay billions in fines and some dealers convicted with up to eleven years imprisonment.
It is clear that in order to avoid manipulations there will be a significant change in the financial world. The consequences after this transition will be mainly operational for the big financial institutions. In other words, the small traders like us won’t be affected in any way. From an economic point of view there will be some tension but, in my opinion, it is less likely to be represented as a market correction. However, this will change the way of making the calculations for our portfolio analyses that’s why I think it is important to follow such a type of news to adapt faster in today’s rapidly changing market conditions.

Written By Valentin Fetvadzhiev

26.07.2018

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