Talking point: The puzzle over LIBOR’s successor

There is no uniform view on what should be the next reference rate for loans, but decisions will need to be taken soon.

LIBOR has been the global reference rate for so long that fund managers have never needed to put much thought into reference rates – they simply based their contracts on LIBOR, as did much of the rest of the lending industry. But with its imminent retirement, firms were forced to examine other options and see where industry consensus settles.

As the retirement of LIBOR was prompted by the UK’s Financial Conduct Authority, the UK has the earliest deadline for firms to stop using LIBOR in their contracts, beginning from January 2022. The result is that British lenders appear to have already settled on using SONIA, a reference rate administered by the Bank of England. SONIA is based on actual transactions and reflects average interest rates that banks pay to borrow sterling overnight from other financial institutions and institutional investors.

But while LIBOR was very much a global reference rate used by banks and alternative lenders across jurisdictions, SONIA seems unlikely to enjoy such global appeal. In the US, firms and regulators are looking at dollar-based reference rates for their loan contracts. The US’s Alternative Reference Rates Committee has put forward the Secured Overnight Financing Rate as a replacement for LIBOR and many, if not all, of the large banks have confirmed their intent to switch from LIBOR to SOFR products.

No consensus

However, the US market has yet to reach a consensus on a replacement benchmark, with three others vying to become the reference rate for US lending. There is Ameribor, an unsecured benchmark created by the American Financial Exchange; Bloomberg Short-Term Bank Yield Index, which launched in January 2021 and is based on actual transactions and executable quotes; and the current LIBOR administrator, ICE Benchmark Administration, has launched its own Bank Yield Index.

The other major market affected by the retirement of LIBOR is the EU, which has opted for another path. The European Central Bank has created the Euro Short-Term Rate benchmark, based on wholesale euro unsecured borrowing costs of banks in the euro area.

With different regions adopting varying deadlines to transition from LIBOR, it could be many months or even years before a definitive industry standard materialises. Only one thing is clear: the half-century long era of a single global reference rate has come to an end.