The London Interbank Offered Rate (LIBOR) is the world’s most important benchmark interest rate that is widely used as a reference rate or index rate for financial instruments and loan products totaling hundreds of trillion of dollars across the globe.
The LIBOR, a multi-use rate, sets the base for the borrowing of unsecured short-term funds between large banks in the interbank market, as well as for calculating the interest rate throughout the world on different kinds of loans.
Until January 31, 2014, the LIBOR was prefixed with BBA, known as BBA LIBOR, as it was administered by the British Bankers Association (BBA). However, On February 1, 2014, the Intercontinental Exchange Benchmark Administration Limited took over the administration of the LIBOR, changing it to the ICE LIBOR.
The Intercontinental Exchange, the authority responsible for LIBOR, will stop publishing one-week and two-month USD LIBOR after Dec. 31, 2021. All other LIBOR will be discontinued after June 30, 2023.
Origins
The origin of the LIBOR goes back to the late 1960s when Minos Zombanakis, a Greek banker organized a syndicated loan worth $80 million for the Shah of Iran from the newly opened London branch of Manufacturers Hanover (now part of JPMorgan Chase).
The loan was pegged to the average of reported funding costs by a few reference banks. The system eventually evolved and was taken over in 1986 by the British Bankers Association (BBA), which formalized the process related to governance and data collection.
Manipulation
The question over LIBOR’s credibility surfaced for the first time during the financial crisis of 2007, when the much-followed rate behaved abruptly and out of line, given other market rates and prices.
In the following years, financial regulators and some public authorities looked into the alleged manipulation of the LIBOR. These investigatory processes exposed many weaknesses of the LIBOR, challenging its credibility as a standard. The main observations were:
- There was a decline in the use of transaction data for LIBOR submissions.
- The submissions that compile the rate were “subject to manipulation” by banks, as such manipulation could help them project better creditworthiness or improve their trading positions.
- The administrative system of the LIBOR had loopholes that provided opportunities to the contributing banks to maneuver rates to suit them. The governance system lacked adequate transparency and accountability resulting in repeated attempts of manipulation.
Though it was clear that some serious misconduct was taking place with regards to LIBOR submissions, nothing substantial was revealed until 2012, when it became clear that banks were misusing their influence over the LIBOR. Investigations over the alleged rigging of the LIBOR were initiated into more than a dozen banks.
The list notably involved Barclays Bank PLC (BARC), UBS (UBS), Royal Bank of Scotland (RBS), HSBC (HSBC), Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), The Bank of Tokyo-Mitsubishi UFJ (BTMU), Credit Suisse, Lloyds (LLOY), WestLB, and Deutsche Bank (DBK).
In June 2012, Barclays Bank was fined £59.5 million by the Financial Services Authority (FSA) for failings related to the LIBOR and EURIBOR in accordance with the Financial Services and Markets Act 2000, mostly between 2005 and 2009. Since Barclays agreed to an early settlement, the fine of £85 million worked out to be £59.5 million after a 30 percent discount.
Barclays was also fined $360 million by U.S. authorities for tampering and false reporting of the EURIBOR and LIBOR between 2005 and 2009.
Wheatley’s Recommendation
In June 2012, soon after Barclays findings were announced (which was only one of the many investigations), the UK Chancellor of the Exchequer commissioned Martin Wheatley (then Managing Director of the Financial Services Authority and Chief Executive designate of the Financial Conduct Authority) to set up an independent review of the various aspects of the LIBOR.
The most important recommendation made by the Wheatley Review of LIBOR (Final Report) was to hand over the LIBOR to a new administrator. According to the Wheatley Review, “The BBA should transfer responsibility for LIBOR to a new administrator, who will be responsible for compiling and distributing the rate, as well as providing credible internal governance and oversight. This should be achieved through a tender process to be run by an independent committee convened by the regulatory authorities.”
Following the Wheatley Review Recommendation, the Hogg Tendering Advisory Committee selected a new administrator of LIBOR via a rigorous competitive tender process. The Hogg Tendering Advisory Committee recommended the Intercontinental Exchange Benchmark Administration (IBA) as the new administrator in mid-2013.
Intercontinental Exchange Group (ICE), a prominent name in the financial world, has a vast network of regulated exchanges and clearinghouses for commodity and financial markets. The IBA, British Bankers Association (BBA), and other industry organizations have worked together to ensure a smooth transition of BBA LIBOR to ICE LIBOR.
And on February 1, 2014, ICE Benchmark Association became the official administrator of the LIBOR, bringing more transparency, as well as a robust oversight and governance framework.
The Bottom Line
The change in the LIBOR administrator did not alter the process of collecting submissions or the way the rate is calculated. However, due to the LIBOR scandals, the Intercontinental Exchange (ICE) has laid out plans to stop the publication of LIBOR. ICE has laid out a tentative date of Dec. 31, 2021, to stop publication of one-week and two-month USD LIBOR, and June 30, 2023, for all other LIBOR. The U.K. Financial Conduct Authority (FCA) and other regulators have been advising end-users to shift away from LIBOR use by 2022.
