Opinion: could we not just have fixed Libor?
The latest setback to the Libor transition came as little surprise to those involved in the process, calling into question the need for replacement rates in the first place
A couple of weeks before this magazine went to press, Libor’s administrator ICE Benchmark Administration (IBA) announced intentions to extend the date of cessation for USD contracts with the most widely used Libor term rates.
Coming as something of a surprise to some, but not all, the announcement caused a stir in the industry and prompted a flurry of analysis – from IFLR included – digging into the news. Some have claimed the delay will offer a welcome reprieve, while others are concerned that deviating from course will likely cause more problems than it fixes.
Sources have also suggested that members of the Alternative Reference Rates Committee (ARRC) had no idea about the delay, despite the fact that the group has been leading the US transition away from the doomed rate for several years.
But let’s put questions of whether this is entirely true aside for a moment. If the people who have spent countless hours trying to make sure the transition from USD Libor to its chosen successor, the Secured Overnight Financing Rate (SOFR), were in the dark, a lot can be gleaned about the murkiness of the overall transition.
Having covered the transition for a number of years, one thing that has become apparent to me is that while banks are toeing the line and pressing ahead with the move towards SOFR, not everybody is entirely happy with how things are going. The lack of a forward looking term SOFR, for one thing, has caused much consternation and appears no closer to resolution as time ticks away.
Whether the 18-month delay does enough to allay fears, and whether stakeholders will use the additional time to ensure that SOFR is a robust and liquid enough rate to replace the trillion-dollar Libor market, remains to be seen.
The rise of the American interbank offered rate – or Ameribor – amongst smaller and community banks in the last year or so is a stark indication that SOFR does not fill the needs of the entire US banking community. The recent announcement from Ameribor’s administrator AFX of a tie-up with Citibank also shows that the entire industry is yet to commit to SOFR. The question is: are an extra 18 months really going to help the ARRC and the Federal Reserve prove that SOFR is the best solution to this problem.
As one source told IFLR confidentially in response to news of the delay: "Citibank, the Bank of America and others, they don't like SOFR at all. They are just going along with it because the Fed wants them to."
Putting competing rates aside, this also begs the question of why the transition away from Libor was necessary in the first place. If banks are questioning new rates and – with just under a year to go until the first major deadline – are still unsure about touted replacements, why are administrators and regulators forcing such a momentous transition on them against their will?
There is a feeling amongst larger participants that if they could roll back the clocks, they would probably have tried to convince the Bank of England to fix Libor, rather than going through the process of replacing it entirely. Across the world, the finance industry is searching for a robust substitute, but why not just make Libor itself more robust? Would fixing Libor not have been easier than replacing it?
See also: Libor reform going round in circles
Libor was the victim of a few bad actors. The actual rate itself performed the function it was designed to do. In the US, at least, SOFR is yet to do that to (/at?) an acceptable level.
For example, SOFR does not have a flexible credit element, or crucially – a forward-looking term rate. ARRC workshops have attempted to fill these gaps, as have alternative rates, but with the deadline looming both remain glaringly absent.
Libor, on the other hand, already performs this function. The issue with Libor is that corrupt actors were able to manipulate it for personal gain, causing a widespread loss of trust in the rate. Reforming Libor to remove this option would surely not have been as technically difficult as the mammoth task of rebuilding the entire process.
Yet when it comes to the Libor transition, the genie is well and truly out of the bottle. The time for choosing reform over replace is long gone, but when the time comes to reflect on the transition and consider what was done well and what could have been done better, the question of whether the entire approach was necessary will undoubtedly be asked.
Libor in all of its guises is very, very useful. Now that its days are numbered, sources are beginning to realise exactly how much they are going to miss it.
See also: Primer on SOFR