Libor Reform Will Impact on All Business Owners
21 September 2015
Practice Area: Banking & Finance
Significant reform of LIBOR, the most popular benchmark for short-term bank borrowing rates, will impact on all lenders and business owners, regardless of level and sector.
LIBOR is referenced for an estimated US$ 350 trillion of outstanding business. Since early 2014 ICE Benchmark Administration Limited (“IBA”), which assumed responsibility for administering LIBOR, has been consulting on significant reform.
IBA plans to implement a more unified and prescriptive transaction-based methodology to restore the integrity and to achieve greater transparency in how the LIBOR rate is set. This drive for transparency will lead to changes in the processes applied by IBA and has already made LIBOR harder to manipulate and distort.
How LIBOR evolves will impact on all business owners regardless of whether their individual trading arrangements are directly linked to the rate or not.
IBA is developing a single, clear, comprehensive and robust LIBOR definition, which is the starting point in developing a benchmark for interest rates that will be fit for purpose. IBA are also considering changes to seek to future-proof LIBOR to ensure the rate can adapt to changing market conditions with appropriate consideration for the interests of all parties.
IBA’s proposals for the evolution of LIBOR rely on the following key principles:
- That users need to understand LIBOR. This is key to any amendments to the practices and procedures implemented by IBA with the acknowledgment that over-complexity will not enhance a benchmark’s credibility;
- Submission criteria need to be transparent and objective and at the same time need to be drafted in such a way that unnecessary complexity is avoided; and
- LIBOR should be anchored to the greatest extent possible in observable market transactions where there is adequate activity. The plan is to implement a more transaction-based approach for determining LIBOR submissions and to continue to introduce safeguards to make LIBOR harder to manipulate.
There is widespread agreement that LIBOR should be based on actual transactions as far as possible and that the pool of available transactions should be widened in response to the changing demands of funding markets. However, there is concern that this approach may result in different standardised parameters depending on the currency, prevailing transaction characteristics and the influential market forces. IBA are consulting on how these factors should be taken into account when calculating a representative overall rate.
IBA plans to expand the range of eligible transactions and counterparties, to standardise the parameters. The calculation techniques applied and the waterfall of methodologies must be coherent across currency markets in order to minimise both the transition risk and the time needed to deliver enhanced and more bespoke rates.
Generally anchoring LIBOR to the greatest extent possible in representative transactions has been welcomed as likely to reduce the risk of manipulation. To ensure the smooth and effective evolution of the new benchmark for interest rates IBA is focussing on capturing consistent and reliable data while permitting LIBOR to adapt to changing market conditions.
The introduction of a more uniform and regimented transaction-based methodology supported by appropriate calculation methods should strengthen LIBOR as a reliable and relevant benchmark and ensure that LIBOR rates can always be made available, even in times of market stress or volatility.