LIBOR and the Coming World
LIBOR used to be known, somewhat hyperbolically, as “the most important figure in the world”. In fact, the rate still determines the interest rate in the performance of different types of global financial operations representing more than $360 trillion US dollars.
The “London Interbank Offered Rate”, as the name implies, is the rate used by London-based banks to lend money to each other in five different foreign currencies for one-day, one-week, one-month, two-months, three-months- six-months and twelve-months terms.
Nevertheless, its importance is based on the fact that it is the reference rate for short-term loans worldwide. Therefore, LIBOR was not the most important figure in the world, but it certainly was a major one, at least for those working in the financial world.
However, and especially due to the 2007/2008 crisis, the manipulation of the rate by financial institutions and high-ranked officers lead to a series of scandals involving several of the main banks of the United Kingdom. As a consequence, some ended up in jail, and high fines were applied.
Thus, worldwide, regulatory agencies and financial institutions started working towards establishing more transparent and trustworthy mechanisms to determine reference rates. Such effort means, in fact, if not the death, the end of LIBOR relevance as a world reference rate.
The key date for these new mechanisms to enter into force is the end of 2021, when the banks that participate in the calculation of LIBOR will no longer be asked for information and, therefore, LIBOR will no longer be published.
This demands two actions from financial operators and regulatory agencies: first, the transparent design of new instruments to calculate rates; second, to get prepared for those changes, especially regarding loans negotiated before these changes take place, but which maturity will take place after 2021.
As for the first action, there are already several mechanisms that started being used and published parallel to LIBOR in the last two years. In the United States, for instance, SOFR (Secured Overnight Financing Rate) has been created, a rate guaranteed by transactions carried out by financial, asset-management, and pension-fund agencies, among others.
The Central European Bank is taking measures to adopt €STR (Euro Short Term Rate) as of October this year, while Japan is going to deploy TONA (Tokyo Overnight Average Rate). In Great Britain, where LIBOR was created, SONIA (Sterling Overnight Index Average) has been chosen to replace it.
Although much preparation, consultation with experts and complex estimates were required, the design of these instruments was, in some way, the easy part of this whole process. The second challenge that we are facing in the financial world is to get prepared for the post-LIBOR world.
While some are comparing the world financial environment with the expectation generated by Y2K (the fear of a worldwide havoc in computers at the beginning of the year 2000), and others expect an unending chain of disputes due to the calculation of the new rates, there is high concern and expectation among institutions, regulatory agencies and governments.
The fact is that the transition will take place and, in order to cope with it, all agents shall have flexibility, patience, creativity, and above all, the will to have a more transparent financial system, less vulnerable to the sort of manipulations witnessed in the past.
It is highly important that institutions like FONPLATA start to handle this topic with its member countries, their governments, regulatory agencies, and central banks, as well as with the major financial institutions that support their work.
Besides, systems shall be adjusted, some of the loan agreements shall be fully reviewed, but, most importantly, the professional and technical staff shall be trained to face the challenges brought up by this change.
My message to all of them is that we are already working towards that goal, we are coordinating and evaluating the transition with other multilateral banks, and we have the human talent, flexibility, and technical capacity to cope with this change. Above all, FONPLATA will continue to be a strong and reliable partner to our member countries and the beneficiaries of our projects.
Text published in Juan E. Notaro’s monthly column in the Huffington Post.