Goodbye, LIBOR

LIBOR, the more than 50-year-old reference rate that came to epitomize Wall Street malfeasance, will soon be no more. The benchmark will have its last fixing at around 6:55 a.m. New York time Friday, fading away with little fanfare after once underpinning hundreds of trillions of dollars of assets globally.

The London interbank offered rate (LIBOR) was never meant to become such an integral part of the financial system, yet it would eventually come to determine the cost of borrowing around the world, from interest-rate swaps and collateralized loan obligations to student loans and mortgages. But the trading that helped determine the rate would dry up, and in the aftermath of the 2008 financial crisis, regulators discovered many of the world’s biggest banks were manipulating LIBOR to their advantage.

After levying billions of dollars in fines, they set about to dismantle it altogether. In the United States, a transition group backed by the Federal Reserve ultimately selected the Secured Overnight Financing Rate (SOFR) as its successor. After some early growing pains, SOFR would eventually supplant LIBOR in most markets, with only a handful of lingering instruments still tied to the much-maligned benchmark.

“Changing something as fundamental as LIBOR has been a great disruption to the status quo, and such transitions in the history of finance have been quite limited,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities. “People are keen to move on to the new rate and market conventions, and begin to settle into new routines.”

LIBOR was derived from a daily survey of bankers who estimated how much they would charge to lend to one another in various currencies. Most regulators have said that the decision to move on from the benchmark was largely based on a lack of underlying trading behind those estimates. Yet for many, LIBOR was irreparably tainted after major financial institutions were accused of submitting bogus rates to boost their trading profits. Banks were forced to pay more than $9 billion in fines.

In 2014, U.S. officials established the Alternative Reference Rates Committee, or ARRC, bringing together representatives from the private sector, regulators, and exchanges to identify an alternative to dollar-denominated LIBOR.

The result was SOFR, a benchmark that was designed to be accessible while also less vulnerable to exploitation. After some initial reticence, most markets would eventually warm up to the new reference rate. Some, including consumer-linked debt and floating-rate notes, were among the earliest to resolve transition issues. Others, including certain types of derivatives and debt securitizations, required more time, prompting officials to delay dollar LIBOR’s final fixing, originally planned for the end of 2021.

In March of last year, U.S. lawmakers passed legislation aimed at ensuring that trillions of dollars of debt which lacked a defined alternative index wouldn’t fall into limbo after LIBOR’s end, clearing one of the last transition hurdles.

Still, observers say there’s one pocket of the financial system that could experience some turbulence following the benchmark’s expiration. They will be keeping a close eye on the $1.4 trillion U.S. leveraged loan market next week, a crucial source of floating-rate financing for many highly indebted companies.

Leveraged loans are crafted as contracts between a company and a group of lenders. That means the ability to switch benchmarks depends on the specific wording in the documents. Many of the loans that haven’t yet made the switch to SOFR already have language in their documents that should make the transition seamless on July 1. But some don’t, and in recent days there’s been a mad dash to rework contracts. Amendments to ditch LIBOR have increased from 14 in January to 84 in May and more than 200 in June, according to data from LevFin Insights, a unit of Fitch Solutions.

Market watchers say a handful of loans may not reach a resolution in time, in which case they’d likely fall back to the prime rate, which is about 3 percentage points higher than SOFR. That could be potentially catastrophic for companies already struggling with rising interest rates.

“For the loan market, it was never going to be flipping a light switch,” said Tess Virmani, deputy general counsel at the LSTA, the industry group for syndicated corporate loans.

Yet for other markets, LIBOR’s ultimate end will probably hardly register at all. In fact, many Wall Street veterans who’ve spend the better part of a decade helping guide the transition have already moved on, or are in the process of doing so.

Priya Misra, former head of global rates strategy at TD Securities and a member of the ARRC, will start a new role at JPMorgan Asset Management in August. Thomas Pluta, the former head of Linear Rates Trading at JPMorgan and also a member of the ARRC, became president of Tradeweb.

Nathaniel Wuerffel, who until recently was the head of domestic markets at the New York Fed and ex-officio member of the ARRC, recently joined Bank of New York Mellon as head of market structure.

Perhaps most notably, Tom Wipf, vice chairman at Morgan Stanley and head of the ARRC for the past four years, will be leaving both the New York-based bank and the transition committee. Replacing him as ARRC chair will be Peter Phelan, a former Treasury Department official and currently chief administrative officer of the institutional client group at Citigroup Inc.

“In the last stage of the transition, we are focused on closing out the ARRC’s work in a way that avoids revisiting this,” Phelan said in an interview. The ARRC “made recommendations collectively to maintain a strong reference rate market. We have worked hard to establish that robust market and ensure that we never have to go through that process again.”

Copyright 2023 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.