With LIBOR Dead, $400 Trillion In Assets Are Stuck In Limbo

In an unexpected announcement, earlier this week the U.K.'s top regulator, the Financial Conduct Authority which is tasked with overseeing Libor, announced that the world's most important, and manipulated, benchmark rate will be phased out by 2021, catching countless FX, credit, derivative, and other traders by surprise because while much attention had been given to possible LIBOR alternatives across the globe (in a time when the credibility of the Libor was non-existent) this was the first time an end date had been suggested for the global benchmark, which as we explained on Thursday, had died from disuse over the past 5 years.

Commenting on the decision, NatWest Markets' Blake Gwinn told Bloomberg that the decision was largely inevitable: “There had never been an answer as to how you get market participants to adopt a new benchmark. It was clear at some point authorities were going to force them. The FCA can compel people to participate in Libor. What can ICE do if they’ve lost the ability to get banks to submit Libor rates?”

And while the rationale for replacing Libor is well understood (for those unfamiliar, read David Enrich's comprehensive account of Libor rigging "The Spider Network"), there are still no clear alternatives. Ultimately, as Bank of America calculates, "moving an existing $9.6 trillion retail mortgage market, $3.5 trillion commercial real estate market, $3.4 trillion loan market and a $350 trillion derivatives market is a herculean task." A partial breakdown of the roughly $400 trillion in global Libor-referencing assets is shown in the table below.

And with nearly half a quadrillion dollar in securities referncing a benchmark that is set to expire in under 5 years, the biggest problem is one of continuity: as Bloomberg calculated last week, in addition to the hundreds of trillion in referencing securities,  there is also currently an open interest of 170,000 eurodollar futures contracts expiring in 2022 and beyond - contracts that settle into a benchmark that will no longer exist. "What are existing contract holders and market makers supposed to do?"

Then there is the question of succession: with over $300 trillion in derivative trades, and countless billions in floating debt contracts, referening Libor, the pressing question is what will replace it, and how will the transition be implemented seamlessly?

According to Bank of America, one possible option to achieve the transition could be to move to a "fixed-spread" Libor benchmark. In this scenario, regulators and market participants could agree for Libor to be hardcoded as a fixed spread over the underlying benchmark of their choice (BTFR-broad Treasury financing rate in the US, SONIA in UK etc). This could help to ensure that contracts that rely on Libor could continue to have a reference rate while the rate itself would move based on the regulator's preferred benchmark.

The option obviously would raise some concerns around what spread to be chosen, the term structure of the fixed spread (for 1m vs. 3m libor for example) - but these, BofA believes, would be easier challenges to address than renegotiating and re-hedging existing contracts.

There is a third problem: while the above scenario could be one option for a short term solution, the longer term concern continues to be the lack of a clear alternative for new contracts. Acccoring to BofA's Mark Cabana, the FCA announcement likely increases activity in the OIS market (both receive and pay flows) - but ultimately, the OIS market (overnight indexed swaps) is based on a fed funds rate whose own future is unclear in a system of non-zero excess reserves dwindling underlying volumes (chart below).

Another option is the BTFR rate (broad Treasury financing rate) which was selected by the Alternative Reference Rates Committee or ARCC (which is having its inaugural meeting on August 1) - but the market has gone down this route before with little success in the GC futures market given declining GCF volumes.

In the end, BofA warns that the most likely emerging scenario is one "involving a fractured derivatives market with multiple underlying benchmarks across different countries developing."Worse, note that the FCA suggests that the IBA and panel banks could continue to produce Libor but the FCA would no longer persuade panel banks to stay.

Finally, what makes the above especially problematic, is that 2021 is when the Fed's balance sheet shrinkage is expected to conclude (according to NY Fed estimates), and when short term rates are to be at their tightening peaks according to sellside estimates. That this will come at a time when there is no effective way to trade, or hedge, unsecured short-term rates - which will by then be roughly 2% higher than where they are now according to the Fed's dot plot...

... will make the Fed's normalization, from a market standpoint, especially "interesting", if not impossible.


Putrid_Scum Dragon HAwk Sat, 07/29/2017 - 14:09 Permalink

Information channels saying US banks have begun to purge credit accounts used to buy Bitcoin and/or Gold. Accounts used to buy Gold and Bitcoin are flagged, shut down, and transactions cancelled. Chase and BoA are confirmed, this has already negatively affected Hedgers planning on buying PMs with debt before The Resetwww.beforethecollapse.com/2017/05/23/the-reset/

In reply to by Dragon HAwk

Mikeyyy A. Boaty Sat, 07/29/2017 - 15:25 Permalink

That's the intent here, but the issue is, what market?  There are flaws pointed out in the article about the various market based measures.   AND, even when an index or security is chosen, all the contracts will have to be rewritten and spreads reconfigured.  It's a massive problem aind one that will not be resolved by 2021.

In reply to by A. Boaty

Ban KKiller Sat, 07/29/2017 - 12:43 Permalink

LIBOR problems fixed with creative accounting...make up new guideline, say "adjustable rate" and jam every former LIBOR tied contract to it. What problem? New guide created by IMF or BIS or....me! 

Rabbi Chaim Cohen Son of Captain Nemo Sat, 07/29/2017 - 13:16 Permalink

Non-issue in these days of insanity, someone will announce new CB policy that changes LIBOR to some new repackaged benchmark OR announce that all previously LIBOR-based securities will no be based on __________, Or ???

The force of Central Banking ostensibly wields the force of law in most of the western world in this "teetering one the precipice" place we find ourselves. To me this means the law will follow the bank's dictate. Everyone will be made to pay up, even for contracts that SHOULD be legally dissolved because of the LIBOR debacle & dissolution.

In reply to by Son of Captain Nemo

Son of Captain Nemo Rabbi Chaim Cohen Sat, 07/29/2017 - 16:08 Permalink

You mean of course until the Petrodollar and everyone else that is pegged to it decide to go there separate ways which started in earnest after 2010...

Which means the Anglo-Zionists will keep doing it with the "hopium" of threatening anyone else at GUN POINT (https://www.rt.com/news/397928-us-warning-shots-iran/) who won't capitulate in buying there securities... And while their bonds continue to smell increasingly rancid every second of every day THAT NO ONE IN THEIR RIGHT MIND WILL OWN... i.e. Russia, Iran, China, North Korean and Syria at the the receiving end (https://southfront.org/sanctions-china-russia-iran-north-korea-part-glo…) as the last remaining holdouts (and soon to be EU members that are ready to call it a day and move the "plantation" East (https://www.rt.com/news/397955-majority-germans-against-russia-sanction…)) the game is nigh finished!...

The only way the existing cadre of CBs in Western Europe and North America will survive is starting WWIII which they know they will LOSE!

Ergo... "DEAD" IS ALREADY "DEAD"!... AND NOT "FRESHLY" either!

Fixed it!!!

In reply to by Rabbi Chaim Cohen

Son of Captain Nemo 7thGenMO Sat, 07/29/2017 - 20:13 Permalink


Allow me to retort...

Money is the catalyst for destroying every vestige of those "freedoms" that you allude to that are being decimated. But remember that with those freedoms of which you speak man has the burden of choice in embracing completely those "false idols" to consume him, or instead another "path"!

Wasn't it that European aristocrat in the 18th Century that served the interests of royalty throughout Western Europe most importantly London that said

"give me control of the money and I care not who makes the laws"!...

Twas always thus And always thus will be....

In reply to by 7thGenMO

Bankster Kibble indio007 Sat, 07/29/2017 - 18:11 Permalink

I've got some questions about that.Who are the big holders of LIBOR priced derivatives?USA gov't guaranteed  $300 trillion of derivatives a few years ago. Does that exposure still exist? And how much volume was LIBOR priced? And will the banks expect payment from Uncle Sam in 2022?At what point do losses in off-balance sheet investments roll onto the income statement? Do they ever get recognized on the balance sheet? Just curious.

In reply to by indio007

Kickaha Sat, 07/29/2017 - 13:00 Permalink

Require the instantaneous internet reporting of all inter-bank loans to a non-profit company run by directors who cannot be bankers and must be appointed by some sort of citizens commission.  Enact penalties for non-reporting or intentional mis-reporting, or gross negligence in reporting, maybe surgical removal of one gonad from the bankers who conspired to try and rig the LIBOR rate via non-reporting, late reporting, or false reporting of any sort.  Second offense:  remove remaining gonad and lifetime ban from financial industy.  Let computer average everything out overnight, and report the average interbank loan rate daily.This is only an issue if people are debating which crooks will fix LIBOR under some new system to replace the old system that allowed the former crooks to fix LIBOR. 

Cloud9.5 Sat, 07/29/2017 - 13:07 Permalink

My ignorance on this topic is huge.  You guys who are smarter than I am tell me how this is going to impact a lowly peasant like myself who has the lion’s share of his wealth in a credit union and local rental properties?

Arnold Cloud9.5 Sat, 07/29/2017 - 13:51 Permalink

Direct influence on what you pay for money.
Not a generic you, YOU.


"Libor is widely used as a reference rate for many financial instruments in both financial markets and commercial fields. There are three major classifications of interest rate fixings instruments, including standard inter bank products, commercial field products, and hybrid products which often use Libor as their reference rate.[19]"


In reply to by Cloud9.5