LIBOR – Chequered past and uncertain future
Monday 17th September 2018
In a speech delivered on 27 July 2017 the Chief Executive of the Financial Conduct Authority (FCA) announced that the FCA had “spoken to all the current panel banks about agreeing voluntarily to sustain LIBOR for a four to five-year period, i.e. until end-2021” with plans to transition away from LIBOR after such date. 
The announcement has given rise to numerous questions in what will happen next regarding LIBOR and alternative reference rates, such as the potential for development of new fallbacks, or repapering for the $300 trillion of financial contracts that LIBOR underpins. 
What is LIBOR?
The London-Interbank Offered Rate, known as ICE LIBOR (since the ICE Benchmark Administration (IBA) became the administrator for LIBOR in February 2014), refers to the globally used benchmark for short term-interest rates, giving an indication of the average rage which LIBOR panel banks could obtain wholesale, unsecured funding for set periods in particular currencies. LIBOR is often the referenced rate for derivative and bond documentation. LIBOR is produced for five currencies (USD, GBP, EUR, CHF and JPY) in seven tenors (Overnight/Spot Next, 1 Week, 1 Month, 2 Months, 3 Months, 6 Months and 12 Months).
A sample of the Panel Composition for LIBOR banks and the currencies they submit for:
The submissions for each currency and tenor pair are ranked by the IBA and the upper and lower quartiles are excluded to remove any outliers. For example, if 16 banks submit for 1 Week GBP, the 4 highest and 4 lowest rates will be removed with the 8 remaining submissions averaged to 5 decimal places to give the relevant rate. Each submission carries an equal weighting, and not every panel bank will submit for each currency. LIBOR for each currency and tenor pairing are usually published at 11:55 am London time on applicable London business days.
Panel banks submissions are based on one question “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 am?”. 
The below image provides a simple indication of the LIBOR process :
Numerous banks have been fined for their activities in the manipulation of LIBOR, but why did banks provide deliberate misrepresentations when giving submissions for LIBOR? There were two key reasons, to increase their profits by giving their traders an advantage, and as a result of the 2008 financial crisis to hide any liquidity issues.
Barclays Bank were the first to be sanctioned for their involvement in LIBOR fixing. Since then JP Morgan, UBS, Royal Bank of Scotland and Deutsche Bank are among those that have been fined by various financial regulators in the UK, US and EU. 
In the US, the Commodity Futures Trading Commission (CFTC) brought proceedings against Barclays which resulted in a $360 million fine by the US authorities for manipulation and false reporting concerning LIBOR and EURIBOR. They put forth that from mid-2005 through to 2009, Barclays based their LIBOR submissions for various currencies on the requests of Barclays swaps traders to benefit their derivative positions, and lowered its LIBOR submissions to hide media perceptions that Barclays had a liquidity problem.  One trader in New York was found to have told their LIBOR submitter “For Monday we are very long 3m cash here in NY and would like the setting to be set as low as possible ... thanks”. 
In the UK, the former regulator the Financial Services Authority fined Barclays Bank plc a record £59.5 million for significant failings relating to LIBOR and EURIBOR. This fine would have been even higher if they have not received a 30% reduction for early settlement.  Barclays were fined for their breach of the then FSA’s Principles for Businesses in relation to their LIBOR and EURIBOR submissions.
Individuals were also punished for their involvement in manipulating the rate. The first of these was Tom Hayes, a former London trader, who was sentenced to 14 years (since reduced to 11 years) in prison for conspiracy to defraud in a case brought by the Serious Fraud Office. 
Following the findings against Barclays in 2012, the Government asked Martin Wheatley to conduct an independent investigation into LIBOR. The subsequent report is known as the Wheatley Review and offered various recommendations regarding LIBOR.
One of the key recommendations from the report was that the British Banking Association (BBA) should transfer its responsibility for LIBOR to a new administrator. As previously mentioned this happened in February 2014 when ICE Benchmark Administration (IBA) became the new administrator.
The Review recommended that the number of currencies and tenors for which LIBOR is published should be reduced. Specifically, Wheatley recommended that all LIBORs for Australian Dollars, Canadian Dollars, Danish Kroner, New Zealand Dollars and Swedish Kronor should be discontinued. The BBA took this recommendation and discontinued LIBOR fixing for these currencies in 2013.
For the remaining currencies, publication of LIBOR for 4 months, 5 months, 7 months, 8 months and 11 months were also subsequently discontinued.
In contrast to the current FCA consensus, the Wheatley Review concluded that LIBOR should be reformed, rather than replaced. 
Joshua Frost, senior vice-president of the Federal Reserve Bank of New York highlights the major issue facing the market if there is not a suitable transition away from LIBOR, “LIBOR is so widely used across a range of markets that if it were to suddenly cease publication, we could see extensive market disruptions”.  It is extremely unlikely that LIBOR will suddenly cease but the market is starting to think about alternatives and making the first steps towards transition.
If we look at how LIBOR is used as a reference rate in relation to OTC derivatives, we can understand the need for alternatives or fallbacks to be put in place. For example, for a fixed to floating interest rate swap, a fixed rate of 1.5% could be exchanged against a floating rate expressed by LIBOR.
ISDAs 2006 Definitions already contain fallbacks for LIBOR (and other IBORs), where they fallback to a poll of four major banks in the relevant interbank market, i.e. London for any LIBOR rate. However, these fallbacks depend upon the reliance of polling reference banks which may not be feasible as it would be required for each relevant payment date. If LIBOR was discontinued, would these banks continue to provide rates indefinitely?
ISDA have expressed the potential for a protocol to amend any legacy transactions. Like other ISDA protocols, this would reduce the need for counterparties to enter into potentially thousands of bilateral amendments and a long repapering exercise. The protocol amendments would apply to all relevant contracts between adhering parties, but would not amend any contracts with non-adhering counterparties. 
In the US, the Secured Overnight Financing Rate (SOFR) has been introduced as a new reference rate developed by the Federal Reserve Bank of New York. SOFR is calculated differently to LIBOR, as it is calculated based upon overnight loans that are collateralised by U.S. government debt, known as repo transactions, in contrast to LIBOR which is based upon banks own expectations of unsecured borrowing for specific periods. 
MetLife Inc., a U.S. insurer have sold a $1 billion-dollar bond tied to SOFR, giving credence to its future as the eventual replacement in the dollar funding market. Previously Barclays Plc were the first bank to issue commercial paper that was tied to the new benchmark. 
In the UK, the Bank of England’s Sterling RFR group identified a reformed SONIA (Sterling Over Night Index Average) as their replacement for GBP LIBOR. 
With both SOFR and SONIA based on actual transactions rather than relying on submissions by banks, it reduces the risk of any manipulation and fixing of the rates that plagued LIBOR. However, as both are overnight rates the issue is still outstanding for how SOFR and SONIA will replace the longer-term tenors offered with LIBOR.
Alternatively, there is the possibility that LIBOR might yet continue to be published beyond 2021. The IBA have stated that they will continue to engage with Panel Banks and market participants through surveys to identify the currency and tenor pairs that are most important to the current users of LIBOR.  Although the IBA are hopeful, any such rate publications will be based on voluntary submission from banks. With LIBOR Panel Banks not compelled to submit rates beyond 2021, we will have to wait and see if they will have any appetite to support the IBA plan to maintain LIBOR.
Impact on documentation
Repapering could be required in some capacity depending on the type of documentation or market preference. For example, if ISDA introduce a protocol, there is the likelihood that some counterparties will not avail of it instead preferring to bilaterally repaper their documentation.
If we consider the 1995 and 2000 version of the Global Master Repurchasing Agreements (GMRA), these both contain references to LIBOR as a defined term that is not contained in the most recent 2011 version. If LIBOR is discontinued, this will need to be rectified. The 2011 version of a GMRA changed the references from LIBOR to an Applicable Rate. With this change, for example, following an Event of Default, it allows the non-Defaulting Party to select an Applicable Rate (rather than LIBOR) allowing for more flexibility to determine an appropriate rate. 
As a side note on the 1995 GMRA, with the support of the ERCC Committee, ICMA will discontinue coverage of the 1995 GMRA in the GMRA legal opinions from 2019 onwards.  Therefore, it is likely that any 1995 GMRA still in use between counterparties will need to be upgraded in the near future.
Following Andrew Bailey’s speech, it appears that LIBOR is destined to be replaced and discontinued. Even if IBA continue to maintain LIBOR after 2021 there is no guarantee that current panel banks will continue to spend time and effort submitting rates if they are no longer being compelled to do so by the FCA. If other references rates appear to be favoured going forward by general market consensus, then it is likely LIBOR will no longer be supported.
Dixit Joshi, Group Treasurer at Deutsche Bank and ISDA’s Board of Directors member summarised the complexity and enormity of the task ahead and it is hard to disagree with his evaluation, “It is not insurmountable but it is complicated. In many ways, this is potentially bigger than Brexit.”
The main challenge for banks and financial institutions is to determine what contracts currently make reference of LIBOR, what trades will be affected past the potential 2021 deadline and if it will require large scale repapering or determine if pre-approved fallbacks sufficient to cover market needs.
It is unlikely there will be any action or clear answers available for the foreseeable future and this will be a gradual process. It will be interesting to keep an eye on industry opinions regarding this transition away from LIBOR and what rates will emerge as the eventual replacements. Any replacement and transition will need to be well managed to avoid and limit disruption to financial markets.