LIBOR Has (Not Yet) Left the Building

Forty years ago today in Indianapolis, for the very last time in history, the King of Rock & Roll stepped up to a microphone and belted out a concert. Elvis Presley transformed music from the moment he set foot on stage, where his signature dancing drove adoring audiences into paroxysms of delight. Over more than two decades spent performing, he never lost his extraordinarily versatile voice – it ranged an astounding 2 and ½ octaves – and he is believed to have sold more than 1 billion records worldwide. In short, Elvis was always on his audiences’ minds, and they couldn’t help falling in love with him.

Yet as Elvis aged, and his body suffered the ravages of long years touring and myriad prescription medications, his onstage presence diminished from being entirely enrapturing to being occasionally incoherent. He was reported to be trapped in unfavorable contracts, like that which gave a 50-50 split to his manager Colonel Tom Parker, even though a 75-25 or even 90-10 split would have been much more consistent with market terms. (Whether or not Parker’s reported manipulation of Elvis was valid, it was crystallized in popular consciousness by vignettes like this: when a reporter once asked Parker, “Is it true you take fifty percent of everything Elvis earns?”, Parker is reputed to have responded, “No, that’s not true; he takes fifty percent of what I earn.”)

Perhaps Elvis knew the time was near, because in 1977 he sang the anthemic “My Way” (written by Paul Anka and popularized by Frank Sinatra) in concert a full forty-one times; this was the most in his career and nearly double his 1976 count, all the more remarkable because he only toured for half of 1977. The song evokes a final reckoning of deeds done, an assessment of regrets, and an endeavor to persevere in one’s course; it’s no surprise ”My Way” remains indelibly associated with the ultimate chapter of Elvis’s career.

As we reflected on the denouement of the King of Rock & Roll’s career, we couldn’t help thinking about the approaching retirement of the King of Interest Rate Benchmarks, LIBOR. From its introduction in 1986, the London Interbank Offered Rate took the financial markets by storm, growing rapidly in utility and global adoption. It never lost its extraordinary versatility – ranging from corporate debt to interest rate derivatives to adjustable-rate mortgages – and became the reference rate for hundreds of trillions of notional in financial contracts worldwide. In short, LIBOR was always on finance practitioners’ minds, and they couldn’t help falling in love with it.

Yet as LIBOR aged, and it proved vulnerable to the ravages of inaccurate submissions and market manipulation, its global credibility diminished significantly. The Wall Street Journal suggested in 2008 that banks were significantly under-reporting their borrowing costs in LIBOR rate submissions, while Mervyn King, Governor of the Bank of England, said that LIBOR was “in many ways the rate at which banks do not lend to each other.” The CFTC released chat transcripts among traders and brokers offering steaks, champagne, and even “a Ferrari next year” in exchange for specific LIBOR fix submissions, and one broker even earned the moniker “Lord LIBOR” for his ability to shape the daily fixing – the once-venerable rate was ignominiously being manipulated.

As market participants realized that we couldn’t go on together with suspicious minds, that it was now or never for LIBOR, they began to plan for an eventual future without it. Central bankers and regulators, concluding that LIBOR was inadequately governed and lacked sufficient real transactions underpinning it, began to consider reforms and alternatives. First, the 2012 Wheatley Review recommended that LIBOR submissions become regulated activities, that the British Bankers Association transfer administration of the rate to a different entity, and that publication of LIBOR cease for currencies and tenors without sufficient liquidity to corroborate submissions. Then in 2014, the Fed convened the Alternative Reference Rates Committee (AARC) to “identify a set of alternative reference interest rates more firmly based on transactions from a robust underlying market,” with analogous efforts convened by central banks in other countries. LIBOR would face its final curtain.

Last Thursday, the AARC announced its preferred alternative reference rate to USD-LIBOR, on the heels of a Bank of England Committee decision for a Sterling-LIBOR alternative in April. Over the next year, central banks and regulators will consult with industry and the public (i.e. a little more conversation) over how to transition to these new rates for interest rate swaps. While more details will emerge, here are five things we already know:

What is the new preferred alternative reference rate? The AARC has identified a broad Treasuries repo financing rate for best practice use in new U.S. dollar derivatives and other financial contracts.

What transactions make up the new preferred alternative reference rate? The new rate will include tri-party repo market, General Collateral Finance Repo Service, and FICC-cleared bilaterally settled Treasury repo transactions.

Why was this specific rate chosen? The AARC chose this rate based on the underlying market’s depth and trading activity, anticipated robustness over time, utility to market participants, consistency with the IOSCO Principles of Financial Benchmarks, and presumed widespread and long-term adoption potential.

What happens to my existing LIBOR-based loans and derivatives? Existing loans and derivatives will continue to reference their contractually stipulated benchmark rate indices.

Will adoption of the proposed alternative reference rate be mandatory? The new rate will be phased in on a voluntary basis based on transition plans to be developed by central banks and regulators in consultation with industry.

As Elvis himself would have said: “Thank you! Thank you very much!”

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