The rocky road to Libor’s end

The “world’s most important number” is to be phased out by the end of 2021. Slow motion or inaction aren’t definitely desirable, but teamwork instead.

It’s hard to overstate the significance of the transition from LIBOR to alternative reference rates. While organisations around the world have begun preparations for this shift and are making progress, more action across a broader set of market participants is needed. Now.

LIBOR – the London Interbank Offered Rate- is so entrenched in the financial markets that its discontinuation as of the end of 2021 represents a major challenge not only for the banking industry but for the financial industry as a whole. In some cases, certain LIBOR currencies or LIBOR tenors might no longer be considered robust even prior to the end of 2021. Equally, “Zombie LIBOR” – or the the scenario where LIBOR survives but with only a few panel banks – is, yet not desirable, a possibility too.

Although banks participation in panels had already been declining and there wasn’t a guarantee they would continue to submit to LIBOR given the legal implications, some financial institutions representatives still consider the FCA’s decision to stop compelling panel banks to contribute to Libor as debatable.

“The only constant in life is change,” the saying goes. In both, our professional and private lives, we deal with change or even disruption (the abrupt change) unavoidably. Yet, we are often resistant to or dismissive of change catalysts. LIBOR’s oblivion – if you allow us to call it like that – infuses an intrinsic need for change in the financial world, far beyond just banking.

History is littered with examples of an initial dismissal or little sympathy for technologies and products that are now so ingrained in our day-by-day that we tend to forget how life was before them. But we’ve also forgotten others. Because LIBOR is strongly rooted in the financial system, the transition away from it will be, to all intents and purposes, challenging.

The frequency of LIBOR-related financial news and the media coverage about the shift to RFRs replacing this and other IBORs (interbank offered rates) show the need for a wake up call in the financial industry. A different take on it is necessary, with all market players working more closely with regulators and administrators .

We all know that the bigger the challenge to our current status quo is, the more resistant we are to the change we must undergo. However, the ostrich strategy is the least needed for a gentle move to new reference rates.

This article’s goal is to remind Luxembourg financial institutions to act now. Due to limited front office activities in the country, they will likely have limited involvement in the transition to RFRs; however, the end of Libor will strongly affect all middle and back office activities, common in Luxembourg. It is desirable for financial institutions to start working ahead the frontline make decisions that they will have to manage later on, locally.

Libor’s scheduled oblivion: why?

We are facing a period of the restructuring of benchmark interest rates (or reference rates) around the world. Although LIBOR is unquestionably the most well-known interbank rate that’s set to be discontinued, there is a general shift away from other IBORs towards the use of RFRs as reference in financial contracts. These risk-free rates are primarily based on actual transactions in overnight markets.

LIBOR’s discontinuation is in response to a market that has severely declined in activity, but it also has to do with a global call to increase transparency in the financial world. LIBOR is calculated by asking panel banks the rate which they are willing to lend to other financial institutions, and it’s listed before noon (London time). Unfortunately, this procedure has been subject to manipulation. Indeed, LIBOR was subject to scrutiny when, in 2012, American media accused panel banks of altering LIBOR rates to favor certain traders’ requests.

Regulatory sponsored industry working groups in each of the nations whose currencies are used for LIBOR submissions have identified RFRs and ARRs (alternative reference rates). For instance, we can cite €STR (Euro Short Term Rate)—the alternative overnight interest rate administered by the European Central Bank, or SARON (Swiss Average Rate Overnight). They have been analysed as LIBOR successors within the context of the European Commission’s Benchmarks Regulation (BMR). However their national administrators are yet to officially obtain the BMR compliance.

This interest rate restructuring has a profound impact on the financial world for two reasons. We explain them below.

IBORs are like certain habits we would like to change. It’s never easy

IBORs’ embeddedness in financial markets is the first reason. They have become benchmark interest rates in markets far beyond the ones they were meant to quantify initially. Nowadays, they are almost omnipresent in models and systems to monitor risk, valuation and discounting. 

Often, IBORs are used in the “background”, updated on a daily basis by automatic systems that operate outside of view. However, even in the cases when financial institutions use them more directly and visibly, their scope and influence have grown far beyond the interbank lending market. 

IBORs are linked to vast volumes of financial contracts, such as interest rate derivatives, cross currency swaps, securitised products and debt instruments.

Currently, LIBOR-linked outstanding financial arrangements around the world – public and private loans and bonds, consumer financial products such as credit cards, mortgages and student loans, interest rate derivatives – represent more than US$350 trillion

The “divide and win” approach, could it work? 

The second reason is related to the divergent methodology to calculate the reference rates that will potentially take over LIBOR’s fundamental role. 

There are different methodologies to determine the various RFRs. One of them is, for instance, a sort of “LIBOR rate + a spread”, somehow linked to the same IBORs calculations used for years.  To ISDAthe International Swaps and Derivatives Association, some regulators and the ARR working groups, spread adjustments are conceptually sound, based on empirical data, and would yield economically equivalent (or at least close to) results. They are still under consultation. 

Whereas LIBOR rates are determined for seven tenorsovernight, one week, one month, two months, three months, six months and twelve monthsRFRs are overnight rates only.  Financial organisms are working on determining how to set term-rates based on the overnight nature of the RFRs.  It’s worth mentioning that there are remarkable similarities in their approaches to do it, for instance, when building a term rate of observed interest rate derivatives. SARON, however, won’t have a term rate.

In the LIBOR affair there isn’t a magic wand

Combine the reasons mentioned above and –you likely agree with us- one could forecast a stormy near future if little action is taken. 

It isn’t because the market isn’t aware of them, but because of the need for a more active involvement of financial market players in the definition of alternatives and the transition to them. Certain underestimation of what is at stake when getting away from LIBOR seems to be thinning the call to action. 

Action is required in all market segments instead, at the frontline and middle and back office activities. 

Regulatory communication calling for a more active implication is increasing; for instance, the “Dear CEO” letter in the UK and the CSSF’s market readiness questionnaire in Luxembourg. 

In the LIBOR affair there isn’t a magic wand. The Luxembourg market seems to be underestimating the impact, and waiting for others to come with solutions that will make the issue go away.

The CSSF asked a selection of Luxembourg market players for a summary of the key risks related to the benchmark reform and an action plan in the move towards a new system of reference rates. In addition, the CSSF also asked these institutions to provide a list of key contacts whose role was overseeing the implementation of the action plans.

Leaving behind LIBOR isn’t a piece of cake. 

To some, there isn’t much to do before having full clarity on the future reference rates and how term-rates will be determined for each of them. 

Sure. Certain matters require clarification before undertaking any implementation but financial institutions can already take actions that will pave the way to the transition to RFRs once the full clarification comes. 

To understand the workload linked to the reference rate transition, it is crucial to know the extent to which your organisation uses the IBORs as benchmarks, directly and indirectly. 

Financial organisations cannot simply “plug” the RFRs into the gap left by the IBORs without further consideration. The transition will surely be more laborious than that. It is important to assess the scale of the adaptation work to be undertaken within your organisation.

Two strong reasons to take action now!

Don’t underestimate what is at stake with the discontinuity of LIBOR and the other IBORs. These are two reasons to take actions now: 

  1. Unpreparedness isn’t an option

Mismanagement of the transition to RFRs can negatively affect your business, resulting in direct financial impacts.

You want to adapt risk and valuation models that are currently based on the IBORs to incorporate the differences that RFRs will bring.  If not done, the prerequisite data for managing your business will be compromised. Likewise, financial products referencing the IBORs will be adjusted. 

  1. Isolation won’t help you get the job done

Your organisation alone cannot conduct a considerable part of the work needed for the transition to RFRs and the later adjustment to their mechanisms. Changes to financial products could require client outreach actions, negotiation with counterparties, market alignment and even external stakeholders education. Similarly, risk and valuation models will likely need to be discussed with external parties such as vendors. 

Communication, negotiation and alignment with external stakeholders will reasonably take longer than any management action or negotiation with internal stakeholders. 

The job to be done is arduous on the rocky road to Libor’s end and the time left for the transition becomes shorter and shorter. The inaction of the market has become a dangerous waiting game, where the forerunners will reap the benefits.

What we think
LIBOR, simply explained
Benjamin Gauthier, Partner at PwC Luxembourg

LIBOR phase out is much more than replacing 5 letters. This interest rate and other IBORs are widely used to perform a diverse range of financial operations. LIBOR, therefore, has become a required parameter for plenty of contracts, financial modelling, product structuring etc. While financial professionals in Luxembourg might not feel directly impacted by its discontinuation – another group entity will take care of replacing it – they will all be affected by the decisions of others later on (i.e. update of prospectus, negotiations with clients, update of accounting processes, valuation, etc.). Getting prepared for it as soon as possible is the safest way to guarantee a smooth transition process.


We thank Pim Aelbers for his valuable support when writing this article.

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