Libor nears its end

Guest authors

The London Interbank Offered Rate, or Libor, is as widely known as it is widely used across global financial markets. However, in around six months’ time, it will cease to exist. We take a look at Libor’s story and how the asset management industry has been preparing for its demise.

Among the raft of coverage about the demise of the London Interbank Offered Rate, otherwise known as Libor, a little-known fact about how the benchmark came about is rarely mentioned.

It was because of the Shah of Iran who, just over 50 years ago, was looking for a multi-million-dollar loan. A panel of banks organised a syndicated variable rate loan and had to decide on a method to reset the rate as interest rates changed. They decided to simply call each other and each bank would say what they thought the rate should be.

The set-up was formalised as Libor in the 1980s. Since then, financial institutions across the globe have used Libor as a reference for the interest rates consumers pay on a wide range of financial products, from credit cards to variable rate mortgages and auto loans. Libor affects literally trillions in loan obligations and has played a fundamental part in how markets function.

However, the landscape changed significantly following the 2008 financial crisis. The number of panel banks reporting their funding rate declined and the remaining banks that did submit a rate reported fewer transactions. Both the Financial Conduct Authority (FCA) and the Bank of England raised concerns about the future sustainability of these rates, with the regulator announcing in 2017 that the banks should no longer submit quotes for Libor after 2021.

Alternative reference rates have emerged

Since the announcement, and similar to other regulators across the globe, both the FCA and the Bank of England have been looking to avoid disruption to markets. They’ve been encouraging a transition away from Libor to the use of alternative reference rates (ARRs).

As Libor is a series of interest rates, quoted in sterling, the US dollar, the euro, the Japanese yen and the Swiss franc, a number of alternative benchmark rates have emerged. This has given asset managers in particular the time to find the benchmarks that are best for them. And in times of volatility, it’s better to have a choice of interest rates than a single benchmark.

In the UK, along with the Working Group on Sterling Risk-Free Reference Rates, the FCA and Bank of England have developed the Sterling Overnight Index Average (Sonia) as the primary interest rate benchmark in sterling markets. Sonia is based on actual transactions and represents the average interest rate that banks pay to borrow sterling overnight from other financial institutions. And in the US, its ARR committee has proposed the Secured Overnight Finance Rate (Sofr) as the preferred replacement for Libor, collateralised by US Treasury securities. Meanwhile, Japanese and Swiss regulators have developed Tonar and Saron respectively.

The impact on the asset management industry is far reaching

The transition away from Libor isn’t a straightforward one. That’s why, since 2017, most asset managers have been looking at their exposure to Libor with a view to ensuring an organised move away from it.

Many have been changing their exposure of affected investments into the new reference rates. As Libor is also used by third parties, such as custodians and fund administrators for valuations and risk analysis, asset managers have also updated systems to integrate the new reference rates.

Most importantly, encouraged by the regulators, asset managers have been providing reassurance to investors that they’re executing the transition from Libor to other reference rates in the right way. They’ve also needed to carefully explain to investors how any new benchmarks differ from those they currently use.

We’re working with fund managers and discretionary managers to make sure our platforms are compliant

Although the impact of Libor’s demise on the asset management industry is significant, it’s just as important that advisers are aware of any impact the changes have on expected performances of funds they recommend to clients. As Libor is also a benchmark for an array of consumer loans, clients may be affected here. So it would be worthwhile for advisers to become familiar with the new alternative reference rates.

A number of fund managers and discretionary managers we partner with on our platforms use Libor as a benchmark and will have to choose a new benchmark before the end of the year. They’re responsible for ensuring their funds and portfolios are compliant with the removal of Libor in advance of the deadline. And, as a platform provider, we’re working with them to ensure an orderly transition by the end of December 2021.

The journey to greater transparency and good outcomes

The demise of Libor has seen the financial services industry and regulators across the globe reset interest rate benchmarks.

The ultimate aim by all is for a smooth transition. And, although it’s the end of the road for Libor, the journey to provide greater transparency and good outcomes for borrowers and investors alike continues.

Speak to your usual contact if you need more information about the end of Libor and the impact it could have on your clients’ investments.

The value of investments can go down as well as up, and could be worth less than originally invested.

The views expressed in this blog should not be regarded as financial advice.