Written by Structured Finance Association President and CEO Michael Bright for American Banker on June 4, 2019
Libor, a decades-old benchmark interest rate, is no longer a viable standard for global finance. In 2017, after years of investigation around false quotes and rate manipulation, the U.K.’s Financial Conduct Authority decided that a transition away from Libor was necessary. After two years of confusion and scandal, the financial world still struggles to find a practical alternative.
Libor represents the rate-average used for $400 trillion in financial contracts globally and $200 trillion in domestic markets. Most American mortgages and student loans are Libor-based, as are many pension and retirement fund investments. “This isn’t an obscure threat off in the distant future,” writes Structured Finance Association President and CEO Michael Bright for American Banker. “It’s a problem that many have identified as a serious risk to our financial markets.” In the United States, there are more than $8 trillion invested in Libor-based contracts, many of which are residential mortgages. These contracts were negotiated assuming Libor’s dependency; it is unclear how a replacement rate might be adopted into their terms.
Bright offers a temporary solution, recommending that all new Libor transactions adopt robust fallback language, anticipating transition to an alternative rate. Bright also suggests that the industry use technology to increase correspondence around existing contracts. Bondholders must collectively amend their legacy business loans to specify a replacement rate. Larger-scale solutions, built around a secured overnight financing rate (SOFR), require continued investigation. If the financial industry fails to commit to this task, it faces a much messier clean-up in the near future.
Read more via American Banker.