In response to the LIBOR scandal, the G20 commissioned the Financial Stability Board to review major interest rate benchmarks.
The board concluded in 2014 that the nearly risk-free reference rates (RFRs) should, in most cases, be considered a more suitable vehicle than reference rates that include a term credit risk component, such as LIBOR.
In the UK, the Financial Conduct Authority (FCA) confirmed in July 2017 that the LIBOR would be phased out as the interest rate index used in calculating floating or adjustable rates for derivatives, bonds, loans, and other financial instruments by the end of 2021. Essentially ensuring its discontinuance as the world’s most widely used benchmark rate.
The GBP LIBOR in the UK is to be replaced by the Sterling Overnight Index Average (SONIA), and is to be administered by the Bank of England. The rate is calculated as the weighted average of the interest rates charged for all unsecured loans reported by market participants in the London overnight market, although only deals of at least GBP 25 million are to be considered when determining the average.
Regulators around the globe have now confirmed that it is time for market participants to commence a transition away from the use of IBORs to alternative benchmark rates. An industry-wide effort is now underway in support of the transition to RFRs, including the establishment of working groups to facilitate the required response. Depending on the IBOR, changes are likely to be made to different products and in different jurisdictions or regions at different times.
The impact of this transition will no doubt be felt far and wide. The challenges are expected to be particularly acute for investment and retail banks, insurance companies, central counterparties, broker-dealers, exchanges, pension funds, asset managers, and hedge funds. However, the ripple effects will also be felt by corporations and consumers as the shift changes valuations on everything from derivatives and corporate bonds through to business and consumer loans.