Libor dozes off to enter $ 265 trillion sunset


By Huw Jones and John McCrank

LONDON / NEW YORK (Reuters) – Bankers and regulators will be on their screens on New Years Eve to see if what was once dubbed the world’s largest number slips into the history books.

The London Interbank Offered Rate, or Libor, is finally deactivated, ending its role of pricing derivatives and loans ranging from mortgages and student loans to corporate finance and credit cards, which totaled $ 265 trillion. dollars around the world in early 2021. The rate is scrapped a decade after banks were caught trying to rig it in what will be the biggest market turmoil since the euro was introduced in 1999.

Its Dec. 31 stop for new business is compared by bankers to “Y2K,” the computer coding that was to wreak havoc on computer systems around the world at the start of the new millennium on Jan. 1, 2000. Banks spent about $ 10 billion dollars are preparing for the demise of Libor, according to an estimate by consulting firm Oliver Wyman.

The year 2000 ultimately saw few major incidents, but regulators are taking no chances with Libor as banks are busy testing their systems.

“I’m going to be at my desk over the Christmas and New Years holidays and I know there will be other people who will be there just in case,” Edwin Schooling Latter, director of markets at the UK Financial Conduct Authority (FCA). .

Many Libor-based derivative markets have already moved to a new benchmark without major disruption. Watchdogs, however, have warned that there could be problems in some credit markets, particularly if borrowers were not made aware of the change, and the impact of the change may not be fully felt. until later in January.

“If you have a contract that references one of these rates, it won’t be there when you look at the screen in January,” said Schooling Latter, who oversees the compilation of Libor from quotes submitted by banks of a market. which has now largely dried up.

Libor began life in a corner of London’s syndicated loan market in 1969 to help price an $ 80 million syndicated loan for the Shah of Iran. Its demise was brought on by regulators after banks around the world were fined billions of dollars for attempting to manipulate the benchmark interest rate in order to make a profit.

It is replaced by rates set by central banks, including the US Federal Reserve, the Bank of England and the European Central Bank.

The US Fed says its Sofr rate to replace Libor is based on roughly $ 1 trillion in daily transactions, which makes it much more difficult to rig.

The complexity of the end of Libor is similar to that of the year 2000, said Thomas Wipf, chairman of the Alternative Reference Rates Committee (ARRC) convened by the Federal Reserve to end the use of Libor in the United States. United.

“I think the need for a lot of pre-planning and a lot of preparation is really consistent, and we look forward to the fact that if we got a little too prepared that would be a good thing,” said Wipf. , who is also vice president of institutional securities at Morgan Stanley.

The Libor has 35 permutations in five currencies from the United States to Europe and Japan, making its demise a huge global undertaking for regulators, banks and businesses since the FCA kicked off in 2017 .

Twenty-four of the 35 permutations disappear completely on December 31, with the rest continuing temporarily for current contracts only, not for new business.

Customers who ignore letters from their bank asking to change the interest rate used on a loan could find themselves in a legal gray area if they do not respond. It may also be difficult in some cases to get enough bondholders to agree to a switch to an alternative rate in time.

“The really interesting part will be January 2022, looking at what comes out of the change in London,” said John Oliver, head of the US Libor transition at PwC consultants.

“It won’t happen on day one, but the first month’s payouts will be where things get really interesting,” Oliver said.

Libor LSEG Chart https://fingfx.thomsonreuters.com/gfx/mkt/dwpkrzjeevm/LSEG%20Libor%20Graphic.PNG

OUT OF THE RACE

About 80% of the $ 265 trillion in Libor-linked contracts outstanding at the start of 2021 were derivatives and swaps that pass through clearing houses, with the remainder mostly being business loans, mortgages and bonds.

Next weekend, the clearing arm of the London Stock Exchange Group, LCH, will “convert” 200,000 Libor sterling swaps with a face value of $ 20 trillion at the Bank of England’s Sonia rate. This follows the conversion of over-the-counter yen, Swiss franc and Euro Libor swaps – derivatives traded directly between two parties – valued at around $ 6 trillion at the start of the month.

“There has been no disruption in the OTC swap market with these conversions, and all sterling swaps will reference Sonia by December 20,” said Susi de Verdelon, Head of SwapClear by LCH.

Osttra Dollar Libor Transition Chart https://fingfx.thomsonreuters.com/gfx/mkt/zdvxoxangpx/Osttra%20Graphic%20on%20US%20Dollar%20Libor%20Transition.PNG

Concern over the market disruption eased significantly after the Fed said five-dollar Libor rates would be held for 18 months until June 2023 for existing contracts but not for new contracts.

The FCA also said the Libor rates on the British pound and the yen will hold in a “synthetic” form – Sonia combined with a fixed spread – for one year.

These two measures, which help laggards catch up, along with contracts incorporating alternative “fallback” rates, mean few people expect widespread disruption, although Asia is behind Europe and the United States in change.

“We’ve seen a lot more activity over the last couple of months, companies are starting to focus a lot more on it now,” said Avinash Thakur, Debt Origination Manager for Asia-Pacific. at Barclays Bank.

“Western nations are the countries that started earlier in this process and Asian businesses don’t think this is such an urgent problem for them, they are less concerned about the problem,” Thakur said.

Libor denominated in dollars represents between half and two-thirds of contracts in progress.

“The story is already moving into next year with the continued remediation of Libor dollar contracts and the adoption of new alternative rate contracts,” said Mark Cankett, partner at Deloitte. “Everyone in the market will want to avoid a cliff at the end of June 2023.”

The banks are pushing for the US Congress to approve a bill that would automatically switch “hard” legacy contracts to an alternate rate and avoid legal limbo when the dollar Libor ends in June 2023.

“We are kind of entering the home stretch, we believe the tools are available to market players to make this transition and we hope the legislative path in the United States will help resolve the difficult legacy,” said Wipf.

Others urged players in the US market not to wait until mid 2023 but to take action by learning from more advanced change in Europe.

“People shouldn’t just rely on legislation. Arriving on January 1, I think we are off to the race,” said Tal Reback, Libor transition manager at KKR Credit and ARRC member of the Fed.

(Reporting by Huw Jones in London and John McCrank in New York, additional reporting by Scott Murdoch, editing by Susan Fenton)

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