Let Libor Survive the Virus to Die Another Day

(Bloomberg Opinion) -- Libor, once dubbed the world’s most important number, is scheduled to perish from the end of next year. With the fallout from the pandemic demanding the full attention of banks, it would be better to grant it an official stay of execution.

The flaws with the London Interbank Offered Rate, the suite of benchmark interest rates governing the value of trillions of dollars of securities, are well known. As well as its vulnerability to rigging by traders who submit the rates, the underlying interbank lending market that guaranteed its historical authority has dwindled to almost nothing.

That explains the desire of market regulators, led by the Financial Conduct Authority in the U.K., to dislodge Libor from its central role in markets. Unfortunately, the international array of mooted replacements — including Sonia in the U.K., SOFR in the U.S. and ESTR in the euro region — are also imperfect.

For one thing, their short maturities as overnight rates have made it difficult to reach a consensus about how to construct a matrix of longer-dated averages, given that the bulk of financial products are based on three-month Libor. And Libor includes a premium for credit risk, which is missing from the successor benchmarks.

Moreover, figures compiled by the International Swaps and Derivatives Association highlight the ongoing failure of the favored replacements for Libor to gain traction in the market for interest-rate derivatives.

In the U.S., more than $2.1 trillion of derivatives tied to Libor traded in the week ended May 8, compared with just $17.2 billion based on SOFR. In the U.K., Libor products worth $337 billion changed hands, almost double the $172 billion of Sonia securities. And in the euro zone, more than 4,000 derivatives worth $545 billion linked to Euribor traded, versus just two contracts worth a negligible amount tied to ESTR.

Market authorities are already allowing some deadlines to slip. A U.K. prohibition against Libor-linked loans designed to halt their origination by the end of September, for example, has been relaxed until the first quarter of next year. The FCA explicitly acknowledged the delay is needed to maintain what it called “the smooth flow of credit to the real economy” as the virus wreaks havoc on companies and consumers. Earlier this month the Bank of England deferred a planned increase in the discount it applies to Libor-linked collateral for central bank loans, shifting the amendment to April from October.

Even before the coronavirus struck, market participants were struggling to adjust to the idea that Libor wouldn’t exist after the end of 2021. With banks at the forefront of efforts to avoid an economic meltdown, their already low appetite to tackle the complicated job of adopting new benchmark borrowing costs will have diminished even further. Regulators should bow to the inevitable, and leave Libor in place past the current deadline. Changing to the new benchmarks is, frankly, a distraction the world of finance can do without for now. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mark Gilbert is a Bloomberg Opinion columnist covering asset management. He previously was the London bureau chief for Bloomberg News. He is also the author of "Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable."

©2020 Bloomberg L.P.

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