LIBOR

Originally, but no longer, an acronym for “London Inter-Bank Offered Rate”, LIBOR is a formal benchmark interest rate.

It gauges the all-in, simple interest rate (including credit premium and liquidity premium) for an unsecured short-term loan that large banks of good credit standing would in the run-up to 11 am each business morning, on request, expect to be offered by another similar institution and (since 1998) which it would accept. It is thus not, since 1998, an "offered rate" as such.

1. Formerly and informally a guess at the interest rate at which large banks of good credit standing might be expected to lend to other such banks in the London inter-bank short-term, unsecured money market at a particular time and in a particular currency. This usage is deprecated.
2. Formally, LIBOR refers to a series of daily unsecured simple-interest-rate benchmarks in several currencies and maturities administered by ICE Benchmark Administration Limited (IBA) but prior to 1 February 2014 by the British Bankers’ Association (the BBA). LIBOR rates are representations of unsecured inter-bank term borrowing costs in the London market each morning. It thus goes without saying that an individual bank does not have its own “LIBOR”.

LIBORs at summer 2014, were published by ICE Benchmarks for:

• CHF (Swiss Franc)
• EUR (Euro)
• GBP (Pound Sterling)
• JPY (Japanese Yen)
• USD (US Dollar).

Australian dollar, Canadian dollar, Danish krone, New Zealand dollar and Swedish krona LIBOR rates were discontinued in early 2013.

LIBOR rates, other than possibly for UK Sterling, are offshore or Eurocurrency rates - rates at which funds may be raised in London, not in the financial centre in the country of origin of the currency concerned.

Since 1 April 2013 the compilation and distribution of LIBOR rates has been a regulated activity under the UK’s Financial Conduct Authority (FCA).

The LIBOR Question

For each currency, a panel of banks contributes rates for use in calculating LIBOR. Each bank is asked, for each currency and maturity to which it contributes:

“At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”

Until 1998, the question was about hypothetical “prime” banks and asked for an "offered rate":

“At what rate do you think interbank term deposits will be offered by one prime bank to another prime bank for a reasonable market size today at 11 am?”

The new question made the rates contributed more linked to each contributing bank – and so more easily subject to review, increasing banks’ accountability for their submissions but meant it was no longer no longer a pure "offered rate". (The "prime bank" approach is still taken by some other ~IBOR type rates around the world.)

In estimating its view of the answer to the LIBOR question, a bank takes account of its knowledge of transactions it has undertaken, its observation of third party transactions and indicative quotes by third parties in the same markets. Expert judgement has to be applied in adjusting observed rates that were not “just prior to 11 am”, or were in adjacent markets but not actually inter-bank deposits, not for institutions of same credit standing or were, for various reasons, not representative. In the extreme case, “In the absence of transaction data relating to a specific LIBOR benchmark, expert judgement alone, in adherence to the LIBOR definition, should be used to determine a submission” (See LIBOR Code of Conduct, below.)

LIBOR calculation

For each of the currencies and periods, rates contributed are ranked and the average of the two middle quartiles of rates submitted is calculated and published. Because panel banks are chosen to represent the larger banks of repute active in London in each currency, LIBORs are not rates applicable to an “average bank” but represent a truncated average of highly regarded, large scale banks. So, many institutions may have to pay more for borrowing, a few less.

LIBOR Code of Conduct

The Code, published by IBA and confirmed by the FCA as Industry Guidance, sets out or annexes the relevant governance and methodology [1]. It does not yet cover the role of the Oversight Committee or of the appointment of contributing banks to panels. (See Early 21st century controversy, below.)

History

The term LIBOR seems to have been first contractually defined in 1970 - for use in relation to what was probably the first Euro-currency (US dollar) floating rate note. This note was organised by Bankers Trust International in London for the Italian oil company ENEL. "LIBOR" had been used informally from the late 1960s to refer to inter-bank rates in London.

In the mid-1980s the BBA and other parties including the Bank of England established working parties that developed the BBA standard for Interest Rate Swaps, “BBAIRS terms”. These provided for the fixing of BBA Interest Settlement Rates that eventually developed into bbalibor™ - LIBOR. BBAIRS terms became standard market practice in 1985. BBA LIBOR rates were published from 1 January 1986, some trial rates having been calculated since 1984.

LIBOR availability eased the further growth of the syndicated loans market and the development of financial instruments such as forward rate agreements and swaps which also required a standardised interest rate benchmark.

On 1 February 2014, the BBA was replaced as Administrator of LIBOR by ICE Benchmark Administration Limited (IBA). IBA has made no immediate changes to the LIBOR process following its take over but it is primary publisher of the rates, taking over from Thomson Reuters. IBA took over from Thomson Reuters (Exeter England) in undertaking the collection, real-time surveillance and calculation services, under the oversight of IBA later in 2014. [[2]]

In late 2014, IBA published a consultation [3] in the form of a Position Paper on the Evolution of ICE LIBOR that proposes a number changes to LIBOR.

Early 21st century: controversy

During the early stages of the global financial crisis that followed the 2008 collapse of Lehman Brothers, concerns began to be raised about the good faith of rates contributed by banks.

The suggestions were twofold:

• that bank staff running interest-rate-affected positions tried to influence rate contributions up or down to suit their own books and/or

• following the collapse of Lehman Brothers in 2008, banks tried to disguise the market’s falling confidence in the banks’ individual credit standing by submitting lower rates than the actual at which they were being offered and accepting funds.

Enquiries in the US and the UK and other countries resulted in administrative action against some banks and criminal action against one bank subsidiary and some individuals.

On 2 April 2013, UK secondary legislation came into force amending the Regulated Activities Order (RAO), making “the administering of, and providing information to, specified benchmarks” a regulated activity under the FSMA (the UK’s Financial Services and Markets Act 2000 as amended). Initially, the only benchmark specified is BBA LIBOR (now ICE LIBOR). The approach to regulation is set out in a Policy Statement PS13/6 [4] of the UK’s Financial Services Authority (FSA) the predecessor of the Financial Conduct Authority (FCA) that took on its responsibilities in April 2013.

In 2013 the FCA approved a Code of Conduct for Contributing Banks to LIBOR as Industry Guidance [5] and changed the Administrator from the original published by the BBA, [6]. The code sets out or annexes the internal governance, audit, compliance, submission methodology and so on required of banks contributing rates.

In August 2014, the Fair and Effective Markets Review of HM Treasury, the Bank of England and the Financial conduct Authority recommended that other FICC benchmarks be brought under the RAO, namely SONIA, RONIA, ISDAFIX, WM/Reuters 4pm London Closing Spot Rate, London Gold Fixing, LBMA Silver Price and ICE Brent.

See also

• ICE LIBOR
• Base rate
• CertFMM
• Cost-plus loan pricing
• Day count conventions
• Effective annual rate
• EURIBOR
• euro LIBOR
• Eurocredit
• Floating rate note
• Forward rate agreement
• LIMEAN
• LIBID
• London InterBank Offered Rate
• New York Funding Rate
• Simple interest
• TIBOR
• Total return swap

Other links

Briefing note: LIBOR Administrator change to ICE Benchmarks from BBA LIBOR, January 2014

Apple Inc. sheds light on Libor, John Grout, ACT May 2013

Libor: Waiting for Wheatley..., John Grout, ACT 2012