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May 1, 2013

Even after choosing a new benchmark – LIBOR may be around for another 30 years

What will replace LIBOR?  The benchmark choice to replace LIBOR seems to be between OIS, GC repo rates and government bond yields.  Too early to call but GC repo seems the consensus front-runner being both liquid and the real cost of most of bank funding (whereas OIS is not so liquid and government bond yields are not closely enough correlated with the cost of bank funding).

When would LIBOR quote based rate setting die?  This FT article (subs.) is the first mention I’ve seen of the issue of how to manage legacy LIBOR swap portfolios during transition to the new benchmark.  Essentially, with swaps running to 30+ years, LIBOR would have to carry on being quoted for decades to come even if the most liquid lending and swaps markets move to a new benchmark.  An illustrative example given is that MIBOR (Madrid Interbank Offered Rate) is still captured for legacy Spanish peseta swaps even though the currency was replaced by the euro about 13  years ago.

What is already available to help?  In the LIBOR replacement case, it feels like CCP settlement swap yields can help (e.g. SwapClear’s here) by providing swap-transaction-based rates for 2 years and up tenor points based on a large pool of interbank transactions.   The missing puzzle piece is a transaction based solution for the shorter term rates than 2 years.

How would the transition begin?  Imagining a market shift to a new benchmark, it seems likely that LIBOR IR futures or LIBOR FRAs would likely become progressively illiquid over a 2-3 year period after a market /regulator consensus was reached on the LIBOR replacement index.

How could short term LIBOR be replaced?  Perhaps LIBOR could be derived from the replacement (transaction-based) index.  Off the cuff the math escapes me – at this point a quant is needed…

Views please on how we can avoid the current LIBOR rate setting process sticking around for another 30+ years?


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