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1 1 (July 26, 2021)

handle is hein.crs/goveecc0001 and id is 1 raw text is: a' rd in~ih isj~at e ' Updated July 26, 2021 The LIBOR Transition LIBOR is a key benchmark interest rate underpinning many financial contracts, butit is scheduled to be discontinued starting at the end of 2021. This In Focus discusses efforts to transition away fromthe use of LIBOR in financial products in order to avoid disruption if LIBOR disappears. LIBOR What Is LIBOR? LIBOR refers to the London Interbank Offered Rate. It is privately determinedby polling more than a dozen large globalbanks in London about the interest rate at which they can borrow for v arious lengths of time (tenors)in U.S. dollars and fourothercurrencies. Thus, at any pointin time, there are severalLIBOR rates. LIBOR dates backto the 1960s and has beenpublished daily since 1986. How Is It Used? LIBOR is a benchmark or referencerate that helps financial market participants gauge prevailing interest rates. In the United States, many financial instruments are tied to dollar LIBORs, including certain floating-rate loans, bonds, securitized products, and financial derivatives. For example, an adjus table mortgage rate might be set at LIBOR plus a fixed markup. Each month, the rate on the mortgage would be reset based on the prevailing LIBOR A type of derivative called an interest rate swap might also reference LIBOR. One party to the swap would receiveaperiodic paymentbasedon a predetermined fixed interest rate, while the otherparty would receive a payment tied to a rate that adjusts basedon the current LIBOR. As of2020, LIBOR was referenced in an estimated $223 trillion of financial instruments. What Was the LIBOR Scandal? In 2012, the British- based bankBarclays was fined by its British regulator and settled with theU.S. Justice Department, Commodity Futures Trading Commission (CFTC), and a group of states for manipulating LIBOR. Barclays was one of the banks that was polled to determine LIBOR From 2005 to 2008, employees at Barclays submitted LIBOR data that did not accurately reflect Barclay s' borrowing costs. They did so for two reasons: (1) to profit from Barclays' swaps trading based onLIBOR and (2) to maskweakness in Barclays' financial condition during the financial crisis. Subsequently, several other banks reached settlements with regulators for manipulating LIBOR and operating a derivatives cartel that involved sharing information on, among other things, LIBOR submissions. Private parties have also sued submitting banks over LIBOR manipulation. An inherent weakness of LIBOR that made it potentially susceptible to manipulation is that on any given day there may be little or no actualborrowing by banks at thevarious tenors that are reported. In that case, polled banks submitted theirbest estimate of what their borrowing costs would be if they wishedto borrow, givingbanks some discretion in what rates they reported. This problemgrew following the financial crisis because banks borrowed les s as a result of the large increase in bankreserves. How Was It Reformed? The LIBOR scandal revealed that a rate determining the value of financial products worth trillions of dollars could be manipulatedby employees at a handfulof banks. Policymakers initiated severalreforms in response to the scandal. First, publicationofthe rate was transferred fromthe British Bankers Association and made more transparent. Second, production of the rate became regulated by the British financial regulator. Third, calculation of the rate was modified to increase the weight on actual data and reduce the weight onbest guesses in the absence of borrowing. Fourth, policymakers have encouraged a transition away fromthe use of LIBOR. What Happens Next? For all but the most popular currencies and tenors, there is insufficient borrowing to determine LIBOR using only borrowing data, so data quality and integrity remains questionable. Participation in the LIBOR sample is voluntary and confers limited benefit, and participants are leery of potential further legal exposure. As aresult, British regulators have announced that LIBOR will be discontinuedbetween December 31, 2021, and June 30,2023. The LIBOR Transition Given LIBOR's shortcomings and its planned dis appearance after 2021, policymakers and market participants are actively encouraging financial institutions to transition fromLIBOR to alternative benchmarks. It is unclear, however, whether sufficient progress has been made to avoid disruption when LIBOR disappears. What Risks Does the LIBOR Transition Pose? Financial firms using LIBORface leg al, operational, credit, regulatory, and reputational risk. In addition, the LIBOR transition may pose s ystemic risk-the risk that a dis ordely transitioncould cause widespread financialinstability. Financial contracts using LIBOR may include fallback language that explicitly addresses what would happen if LIBOR is discontinued. These contracts are less problematic thanlegacy contracts that do notinclude fallbacklanguage and mature after LIBOR's disappearance. If unaddressed, legacy contracts could stop functioning or lead to leg al action between parties to the contracts. Parties to a legacy contract can mitigate these risks by amending contracts to incorporate robust fallback language. However, in many cases, allparties must agree to an amendment.

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