Replacing LIBOR, the predominant derivatives and fixed-income valuation benchmark that's been bruised by accusations of bank manipulation, could leave institutional investors a little beaten up as well by 2021, the suggested date for moving away from the rate.
That's because many investments pegged to the London interbank offered rate, such as interest-rate swaps and long-duration fixed income, will require investors to renegotiate with counterparties to agree on a new benchmark — with potential negative ramifications on a market that totals trillions of dollars of investments, sources said.
"The issue has always been that LIBOR is the base at which to price a spread," said Mark Unferth, portfolio manager, ACR Alpine Capital Research LLC, Clayton, Mo. He said the leveraged-loan market alone accounts for $1 trillion in assets, all of which will be affected by any change away from LIBOR. "We never had to think about it. Every agreement for loan repricing was LIBOR plus the spread. That makes this a floating-rate asset class. As the Fed raised rates, LIBOR naturally went up, or down in a lower-rate environment. But no one had to think about it."
Added Eric Bernstein, president, asset management solutions, Broadridge Financial Solutions Inc., Lake Success, N.Y.: "There will be a lot of challenges for anyone that uses a third-party administrator — which is basically all of the buy side with accounting and reconciliation systems. People may not be happy with the construct of LIBOR, which is fine. But many don't grasp what it will take to replace it."
The Federal Reserve Bank, the Bank of England and the European Central Bank are recommending a market- or transaction-based rate to replace LIBOR, the interest rate at which banks lend money to each other. That rate is the average of daily estimates submitted by member banks and overseen by Intercontinental Exchange Inc. — and it's the alleged manipulation of those rates that has led to billions of dollars in settlements reached by banks and regulatory agencies since 2012.
LIBOR is set at different currencies, including the U.S. dollar, British pound and euro, but an alphabet soup of replacement rates introduced by central banks relate to their own currencies. They include the Fed's secured overnight financing rate, or SOFR; the Bank of England's sterling overnight index average, or SONIA; the ECB's euro short-term rate, or ESTER; the Swiss National Bank's average rate overnight, or SARON; and the Bank of Japan's Tokyo overnight average rate, or TONAR.