This year will bring big changes, at least when it comes to financial markets. Namely, 2021 is when the long-awaited abolition of LIBOR will take place. Although there was a lot of talk about technical obstacles that need to be overcome, change was seemingly inevitable.
LIBOR (London Interbank Offered Rate) is the daily reference interest rate at which banks lend to each other on the interbank market. It gained in importance in the 1990s, when the British Banking Association (“BBA”) settled relevant standards of regulation, the collection and analysis of data obtained, which will serve as a basis for calculating the rates on which LIBOR will be based. With the approval of the Financial Conduct Authority (“FCA”), the BBA transferred the administration of LIBOR to the ICE Benchmark Administration (“IBA”), after which the IBA became responsible for overseeing five currencies:
Based on reports submitted by the so-called panel of banks, rates of these currencies dictate the LIBOR rate. The panel of banks is made by nearly 20 banks, each representing trade in a specific currency. A bank qualifies for the panel based on the amount of trading it handles in a currency as well as its market reputation and some additional parameters. LIBOR is calculated daily for different maturities: daily (overnight), weekly, monthly, as well as for a period of 2, 3, 6 and 12 months.
Even though it seemed that this whole system was well developed and functioning, that wasn’t really the case. Back in 2012, numerous LIBOR-related scandals broke out. To increase profits, many banks adjusted the value of their rates which eventually led to a miscalculation of the benchmark rate. Some of those banks were fined hundreds of millions of dollars. In addition, the FCA, as well as other regulators in the financial sector, expressed concern that the reference interest rate no longer reflected the real state of the market. Thereafter, a decision was made to replace LIBOR after approximately 30 years.
The plan is that the sterling, euro, Swiss franc and Japanese yen LIBOR panels, as well as panels for the 1-week and 2-month US dollar LIBOR, will cease their operations at the end of 2021, with the remaining US dollar LIBOR panels ceasing to exist at the end of June 2023. The termination of the calculation for the US dollar was postponed until mid-2023, since more bonds and loans are tied to the currency. Banks should withdraw contracts worth over $350 billion tied to this reference interest rate.
LIBOR will be replaced by overnight interest rates (Risk-free rate – RFR). These are essentially short-term interest rates, formed among banks on so-called overnight loans. The short-term interest rate that will most likely replace GBP LIBOR is SONIA (Sterling Overnight Index Average). SONIA was introduced back in 1997, as a response to the increased volume of transactions that take place after hours. SONIA is determined as the weighted average of the total unsecured cash transactions made within the members of the WMBA (The Wholesale Markets Brokers Association). As such, it is an excellent indicator of daily traffic. Just like the sterling will have SONIA, other currencies will have their own rates such as €STR (Euro Short-Term Rate), SARON (Swiss Average Rate Overnight), TONAR (Tokyo Overnight Average Rate) and SOFR (Secured Overnight Financing Rate).
Although the transition from one reference interest rate to another will incur significant costs, regulators consider it inevitable. The new reference rates will realistically reflect the situation on the financial markets, simultaneously affecting the security of consumers, something that the LIBOR embezzlement noticeably disrupted over the years.
However, the phasing out of the rate will not have a significant impact on the Serbian market. Namely, contracts on the Serbian market are most often related to EURIBOR, and not to LIBOR. EURIBOR (Euro Interbank Offered Rate) is the interest rate at which banks exchange deposits in euros on the European money market. Euro-indexed loans are dominant in the portfolio of the Serbian banking sector, thus, making the impact in Serbia minor.
However, a globalized world means that all financial markets are closely connected. The exact impact of the end of LIBOR is yet to be seen.
Authors: Danica Misojčić, Teodora Ristić
