The end of LIBOR is (finally) here

The painstaking, decade-long process of ending the financial system’s reliance on a degraded interest rate benchmark, which once underpinned trillions of dollars in contracts around the world, is almost over. Starting next week, the rate, better known as the London Interbank Offered Rate, or LIBOR for short, will no longer be published.

LIBOR is a collective name for dozens of rates, denominated in different currencies, intended to reflect how much it costs banks to borrow from each other. That rate is important because it reflects the basic costs that banks pass on to customers. The ups and downs in LIBOR have been reflected in many mortgages, student loans, corporate bonds and a wide variety of financial derivatives, which began more than 50 years ago.

In 2012, British bank Barclays became the first of many to be fined by regulators for manipulating LIBOR, which was compiled by taking an average of the rates quoted daily by a relatively small panel of banks. The entries were supposed to reflect market conditions, but because they were not explicitly linked to actual trading, the submitters were accused of abusing the system by quoting higher or lower rates to benefit specific transactions. Ultimately, about $10 billion in fines were handed out in the financial sector over allegations of LIBOR fraud, leading to efforts to distance themselves from the tainted benchmark.

This week that gigantic effort crosses the finish line.

“LIBOR was a ubiquitous rate across all global financial products; it was the single most important benchmark in the world, and it was a really huge effort to get the market off of that,” said Mark Cabana, head of US interest rate strategy at Bank of America. “There are still problems, but it is remarkable that LIBOR is going out with more whimpers than bangs. That was unthinkable years ago.”

In the United States, LIBOR is replaced by the Secured Overnight Financing Rate, or SOFR. Unlike LIBOR, SOFR represents the cost of borrowing for a wider variety of market participants and is based on actual transactions in overnight lending markets.

The process to replace LIBOR began in earnest in 2014, with the formation of the Alternative Reference Rates Committee, a group of industry representatives and regulators who decided in 2017 to replace LIBOR with SOFR. Since then, a massive exercise has taken place to inform banks, fund managers and others about the transition and push them to transfer contracts to the new rate. From 2022, new deals should not be linked to LIBOR.

But many contracts written before then, and even some after, still refer to the LIBOR benchmark, and a last-minute effort has been made to meet this week’s deadline.

For example, according to JPMorgan Chase, about half of the $1.4 trillion loan market has switched to paying interest tied to SOFR. Most of the rest of the market has adopted language in loan documents that will take loans still tied to LIBOR and convert them to SOFR next week.

“It’s been a mammoth amount of work,” said Meredith Coffey, who has been part of the transition effort since 2017 as co-head of policy at the Loan Syndications and Trading Association. “When we started talking to people in the money markets and telling them LIBOR was going to stop, they thought we were crazy.”

A small portion of the loan market — about 8 percent, or about $100 billion — has no fallback language, according to data from the research firm Covenant Review. Most of those loans are from riskier borrowers who have struggled to refinance their debt to refer to SOFR.

Analysts said most of these companies could benefit from a decision made this year by UK regulators, which oversee LIBOR, to publish a rate that mimics LIBOR until September 2024. This zombie-like rate is designed to prevent post-deadline market disruptions.

Still, a small number of businesses may be forced to use the so-called prime rate, which reflects the cost for consumers to borrow from commercial banks — a rate much higher than what banks charge each other. With some borrowers already weighed down by the Federal Reserve’s drastic increase in interest rates over the past year, the blow from the move to the prime rate could have dire consequences, the rating agency Fitch warned.

“This has been a colossal change,” said Tal Reback, a director at the investment firm KKR and a member of the industry committee leading the LIBOR transition. “It is a redesign of global financial markets that has been accompanied by a global pandemic, extreme inflation and rising interest rates. There will be growing pains, but by all accounts, it’s time to say, ‘Rest in peace, LIBOR.’”