LIBOR Prepares for the End and Countries Must Rush to the Change


June 4, 2021, | AtoZ Markets -ICE LIBOR (also known as LIBOR), or London Interbank Offered Rate, is part of the group of interbank offered rates that exists worldwide and for many years accompanied the financial market as a vital part of risk management. However, this old companion of analysts and investors is preparing for its end once this year comes to an end.

The LIBOR rate is used to determine the price of various financial instruments, including derivatives and futures. After long years of controversy over whether or not there was manipulation of LIBOR rates by some bankers, the UK financial markets regulator decided to phase it out.

However, although most of the benchmark will cease to exist by the end of this year, a few US dollar adjustments will cease only until June 30, 2023.

LIBOR is normally published for each currency and tenor combination at 11:55 am London time on each applicable London business day.

But What Is the LIBOR and Why Is It Important?

The LIBOR methodology is designed to produce an average rate that is representative of the rates at which large, leading internationally active banks with access to the wholesale, unsecured funding market could fund themselves in such market in particular currencies for certain tenors.

LIBOR is currently calculated for five currencies (USD, GBP, EUR, CHF and JPY) and for seven tenors in respect of each currency (Overnight/Spot Next, One Week, One Month, Two Months, Three Months, Six Months and 12 Months).

This results in the publication of 35 individual rates (one for each currency and tenor combination) every applicable London business day.

Used globally, LIBOR is often referenced in derivative, bond and loan documentation, and in a range of consumer lending instruments such as mortgages and student loans.

It is also used as a gauge of market expectation regarding central bank interest rates, liquidity premiums in the money markets and, during periods of stress, as an indicator of the health of the banking system.

Who Will Replace the LIBOR?

Although there is no one-size-fits-all solution, in the UK, the new benchmark will be SONIA (Sterling Overnight In the UK, the new benchmark will be SONIA (Sterling Overnight Index Average), which is a benchmark that has been in existence for 20 years.

In addition to, The Secured Overnight Funding Rate (SOFR) is the proposed alternative to USD LIBOR. However, there are differences between the two benchmarks.

For example, SOFR is much more sensitive to daily market movements than LIBOR.

In global markets, there are more than $ 200 trillion of securities that have some link to a LIBOR. 

ICE Benchmark Administration’s (IBA) solutions designed to help stakeholders prepare for transition to new U.S. Dollar interest rate benchmarks.

 

Meanwhile, most countries in the world are already working on the transition to SOFR rates, but some like Australia are a bit behind, while
the Reserve Bank of Australia (RBA) have asked that this process be carried out in a faster way.

How Does LIBOR Affect Traders?

In addition to being used to set interest rates on financial contracts and derivatives, LIBOR also influences mortgage rates, student loans and credit cards.

At the end of each trading day  positions held in your account may be subject to a charge called a “swap or rollover”. The charge may be positive or negative, depending on the direction of your trade and the applicable rate.

The swap is automatically charged and converted to the currency in which the investor’s account is denominated.

The swap is calculated and charged once each weekday for 1 rollover day, with the exception of Wednesdays, when it is calculated and charged 3 times to the account because the weekend.

As we can see, the end of the LIBOR rate brings many challenges to the financial market in general, and it will also affect us in one way or another.

In the case of the Euro, however, the reference rate is called the Euribor rate, and is managed by the European Banking Federation.

There is a Euro LIBOR, but it is mainly used for continuity purposes in swap contracts.

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