Benchmark interest rates are a core component of global financial markets, influencing borrowing and lending for all types of market participants across a myriad of financial instruments. Retail and commercial loans, corporate debt, securitised products, and the derivatives markets all rely on these benchmark reference rates for the pricing and hedging of interest rates and other risks.
The London Interbank Offer Rate, or LIBOR, is one of the most common series of benchmark rates referenced by contracts measured in the trillions of dollars across global currencies. Following the financial crisis, calls grew to reform the process used to price LIBOR due to the way the rate was developed based on professional judgment by contributing banks, the lack of transactional data from which to derive such rates, and the potential for the rate-setting process to be manipulated as seen by regulatory enforcement actions and litigation in recent years.
“I cannot entirely discount the risk of earlier panel degradation, or having to fall back to use of our powers to compel, with all the costs and risks of a messier and more costly transition that this might crystallise. Market participants should continue to have those risks in mind as the work on transition gets started.”
As a result, regulatory and advisory bodies, working with market participants in various jurisdictions around the world, have begun releasing plans to retire existing benchmarks and begin the process of developing replacements. This culminated in the UK Financial Conduct Authority’s decision to no longer compel panel banks to participate in the LIBOR submission process after the end of 2021.
In this publication, we highlight some of the numerous challenges that will need to be addressed as the future of LIBOR remains uncertain and as the journey toward alternative benchmarks progresses.