The Libor transition remains underway for the major currencies of the world whose reliance on Libor in the past decades has been extensive.
Jonathan Rosen, Ph.D, Product Manager, Quantitative Analytics, FINCAD
While EU firms are by now well aware of the subdued impacts of domestic interest-rate benchmark changes, owing to the longevity of recently reformed Euribor and the elegant solution of replacing EONIA with ESTR envisaged in the recent past – it is now a much greater question how foreign Libor benchmarks may continue to impact European firms over the next several years.
Unlike the active story around alternative rates still unfolding in the US, the UK has continually taken the hard-line approach to replacing GBP Libor with SONIA. This has required unwavering commitment to this change throughout the tumult of COVID-19 and the events of 2020/21 which have put significant pressure on many businesses and banks forced to navigate these turbulent times. Because of this, there is a high degree of uncertainty over how the future of Sterling interest-rate benchmarks will look.
In contrast, the regulators in the US and Japan have shown a greater degree of tolerance for multiple possible alternatives to USD Libor and JPY Libor. In the US, the Libor deadline postponement until 2023 has given rise to competing interests with different preferences for the future of interest-rate benchmarks such as BSBY, Ameribor, and term-SOFR (tentatively forthcoming). On the other hand, an entrenched interest in the compounded overnight rate SOFR as a potential replacement for the vast array of instruments which reference USD Libor has the backing so far of US regulators.
In Japan a somewhat similar tolerance for a variety of new benchmarks is taking place. In particular, the reform and expansion of scope for domestic Tibor rates administered by the Bank of Japan in addition to the risk-free overnight rate TONA. While the London-based JPY Libor is clearly destined for an imminent demise, there is enough potential wiggle room for it to be unclear where the markets will consolidate and to what extent the markets around TONA as a payment benchmark will continue to develop.
For European businesses this is a period of time now characterized by domestic stability of interest-rate benchmarks, but also wrought with foreign exposure conundrums particularly related to the important US dollar and JPY yen. The ability to operate FX-rate exposed business lines will mean managing risk not only to Euribor and JPY/USD based Libor rates, but also to have the level of readiness to take on instruments linked to one of possibly numerous benchmark rates in a landscape of liquidity limitations, up until a time where the transition is clarified with the consensus for benchmark rates used internationally. While islands of stability are beginning to form, and in particular the straightforward European approach to benchmark reform builds complacency to these issues, it is important to remember that a significant portion of the globe is still in a state of uncertainty about the future of international interest rate benchmarks.
About the Author Jonathan Rosen, Ph.D, Product Manager, Quantitative Analytics
Jonathan oversees analytics development for FINCAD’s products and solutions. Before joining FINCAD’s product management team in 2016, he worked as a senior quant solving a wide range of problems in the financial tech industry. Jonathan holds a PhD in Physics from the University of British Columbia. https://fincad.com/
