LIBOR’s future in jeopardy?

The significant improvements brought to the most famous IBOR might prove a pointless exercise.

Improvements to LIBOR

Further to the Wheatley Report in the UK, LIBOR was brought under the regulatory scope of the FCA as the first (and only) specified benchmark. The administration of LIBOR was transferred from the old BBA LIBOR to the brand new ICE Benchmark Administration Limited (IBA). In addition, an in-depth report on the implementation of the IOSCO Principles for financial benchmarks by the administrators of LIBOR was published on 22 July 2014. The few shortcomings revealed by the report are expected to be rapidly addressed by the administrators.

The IOSCO principles are the international standards that benchmarks are expected to follow and form the backbone of the EU proposal for benchmark regulation. But full compliance with IOSCO principles might offer only a temporary shelter for LIBOR.

Weakness of LIBOR

Leopards change their spots rarely at best.  As its name implies, it is in the nature of the LIBOR to include a risk premium for bank credit risk. Market stress directed at the banking sector might have repercussions on a vast array of financial products which would have been otherwise unrelated to the borrowing costs of banks. Hence the need for a risk free, or nearly risk free rate, to be used as a reference when appropriate.

Full FSB Report on the issue

On 22 July 2014, the FSB published the report “Reforming Major Interest Rate Benchmarks”, in which it advocates for:

• Strengthening existing “X”IBORs as to become transaction-based
• Developing alternative risk free, or nearly risk free reference rates

The high-level Official Sector Steering Group (OSSG) was mandated to conduct the review of the issue. A Market Participants Group was put in place, which produced a 750 page detailed report . It was recognised that the market is unlikely to move voluntarily from LIBOR to available alternatives.

US Regulators frowning

The FSB report hinted that the Federal Reserve was keener to take action. In a recent article by Risk.net, Jerome Powell who is a member of the Federal Reserve System and co-chaired the OSSG, sounds determined to resolve this issue. Powell would support measures to compel a move away from the LIBOR. It would also very conveniently create the opportunity to push for US based / US supervised reference rates and put an end to the UK supremacy in this matter.

UK’s reaction is likely to be lukewarm, in light of all the efforts made towards the root and branch reform of the LIBOR.

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