In focus

Breaking up is hard to do: A state-of-the-state update on the LIBOR transition

LIBOR was designed to reflect the funding costs of global banks. While three-month US Dollar LIBOR (3mL) became the standard global benchmark for pricing floating-rate risk, over time it drew criticism as rate settings were increasingly based on estimates instead of actual market transactions. During the Global Financial Crisis (GFC), this resulted in distortions and manipulation by banks submitting quotes. After being accused of malfeasance and paying substantial fines these panel banks withdrew from the market accelerating LIBORs decline.

To avoid a Minsky moment, the Financial Conduct Authority (FCA) – the regulator responsible for LIBOR – announced that LIBOR would be sustained until the end of 2021 to give the market time to transition LIBOR-linked obligations to a more robust reference rate.

However, last year, as the pandemic and its consequences captured the attention of policy makers and the market, the clock started to run down on LIBOR’s end. While the one-week and two-month USD LIBOR rates, as well as the Sterling, Euro, Swiss Franc, and Yen rates, will no longer be published beyond the end of 2021, on March 5, 2021, the FCA gave the market a reprieve by announcing it would sustain the most widely used USD LIBOR rates until the end of June 2023. This extension gives the market time to address inadequate contract language while also allowing for the natural maturity of USD LIBOR exposures that do not have a clear description of what rate would apply when LIBOR settings are not available. Despite this step to mediate market turmoil there remain transition challenges.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.