Turning point in journey to less risky rates

Efforts to reform LIBOR and the existing rates benchmarking framework have been ongoing for several years.
Andy Ross, CEO, CurveGlobalAndy Ross, CEO, CurveGlobal
Andy Ross, CEO, CurveGlobal

We’ve now reached a new turning point in the journey to alternative, less risky rates, with the path to transition looking clearer. But what is LIBOR?

Often abbreviated, the London interbank offer rate is a global benchmark interest rate, which is used to set the pricing for an estimated $350 trillion of financial products, often referred to as the world’s biggest number. The LIBOR rate underpins the cost of government borrowing, complex financial products, such as interest rate derivatives, as well as things like student loans, business and consumer loans, credit cards, mortgages and savings accounts.

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As well as helping to set the price of financial transactions and products, LIBOR has also traditionally been used to gauge trust in the financial system and as an indicator of the confidence banks have in each other's financial health.

Calculated on a daily basis, the LIBOR rate is established through by a survey of banks in which they are asked to estimate the rate they would charge to lend to each other. However, since these rates are estimates, rather than actual transactions, LIBOR had the potential to be manipulated.

Following allegations that some traders had manipulated the rate, regulators around the world began to investigate in 2012. This resulted in billions of pounds of fines and settlements. .

Subsequently, the way LIBOR has been calculated has changed to more closely reflect actual prices banks pay to borrow from each other. As this type of lending has become increasingly rare the rate has been harder to calculate and increased potential risks for the banks submitting rates.

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In 2017, the Financial Conduct Authority (FCA) announced it would phase out LIBOR by 2021.

With trillions of pounds of financial products based on LIBOR, many with end dates years beyond 2021, it’s imperative that market participants have the tools to move away from LIBOR and start the transition as soon as possible.

Authorities in the UK and the US have both stated that there is no time to waste. As an alternative, the Bank of England has proposed using another rate: SONIA. Short for Sterling overnight index average, based on the average rates of actual borrowing, rather than estimates, SONIA is what’s called a risk free rate.

London Stock Exchange Group has a track record of innovation and promotes trusted and transparent environments and services for investment. As part of this, CurveGlobal, an interest rate derivatives platform created as a venture between London Stock Exchange Group and a number of market participants, launched an interest rate product called the three-month SONIA futures

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contract. The new product went live on 30 April 2018, just a week after the Bank of England launched the new SONIA rate.

Through the CurveGlobal platform, market participants can trade LIBOR and SONIA futures simultaneously, enabling the interest rate futures market to make a smooth and orderly transition to the new risk free rate. It’s just one of the ways we’re bringing innovation, choice and competition to the markets.

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