LIBOR and Counterparty risk: Difference between pages

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


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 which it would accept.
When a contract is in the money, the risk that the other party to the contract fails for any reason, for example bankruptcy.


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 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”.
2.


From 1 April 2013 the compilation and distribution of LIBOR rates is a regulated activity under the UK’s Financial Conduct Authority.
More generally, the risk to each party to a contract that the counterparty will not meet its contractual obligations, whether they are unable, or simply unwilling, to do so.
 
In summer 2013 it was announced that in early 2014 the BBA will be replaced as administrator of LIBOR by NYSE Euronext Rates Administration Limited (ERA) [http://www.bba.org.uk/media/article/bba-to-hand-over-administration-of-libor-to-nyse-euronext-rate-administrati/press-releases/]. On 13 November 2013 NYSE Euronext was acquired by IntercontinentalExchange Group, Inc. ERA has become Interncontinental Benchmark Administration Limited (IBA). IBA has taken over administration of Libor with effect from 1 February 2014, issuing the first rates on 3 February. IBA has said that there will be no immediate changes to the Libor process following its take over but it will itself be primary publisher of the rates, taking over from Thomson Reuters, but Thomson Reuters in Exeter England, will continue to undertake the collection, real-time surveillance and calculation services, under the oversight of IBA. [[https://www.theice.com/iba.jhtml]]
 
 
==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 1988, the question was about hypothetical “prime” banks:
 
“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.
 
 
==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.
 
 
==History==
 
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 September 1985. LIBOR rates have been published since 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.
 
 
==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 that, 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, 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. The approach to regulation is set out in a Policy Statement PS13/6 [http://www.fsa.gov.uk/static/pubs/policy/ps13-06.pdf] of the UK’s Financial Services Authority (FSA) the predecessor of the Financial conduct Authority (FCA) that took on its responsibilities in April 2013.
 
On 15 July 2013 the FCA approved a Code of Conduct for Contributing Banks to LIBOR as Industry Guidance [http://www.bbalibor.com/download/9070]. The code sets out the internal governance, audit, compliance and so on required of banks contributing rates. The Code also has annexed the submission methodology to be followed by contributing banks.
 
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 also ==
== See also ==
* [[Base rate]]
*[[Cash in the new post-crisis world]]
* [[Cost-plus loan pricing]]
*[[CCR]]
* [[Effective annual rate]]
*[[CRD IV]]
* [[EURIBOR]]
*[[Credit risk]]
* [[euro LIBOR]]
*[[Guide to risk management]]
* [[Eurocredit]]
*[[In the money]]
* [[Floating rate note]]
*[[Putting a limit on losses]]
* [[Forward rate agreement]]
*[[Risk]]
* [[LIMEAN]]
* [[LIBID]]
* [[London InterBank Offered Rate]]
* [[Simple interest]]
* [[TIBOR]]
* [[Total return swap]]
 
 
== Other links ==


[http://www.treasurers.org/node/9062 Apple Inc. sheds light on Libor, John Grout, ACT May 2013]


[http://www.treasurers.org/node/8064 Libor: Waiting for Wheatley..., John Grout, ACT 2012]
==Other resource==
*[http://www.treasurers.org/node/8928 Treasury essentials: Counterparty risk, The Treasurer, April 2013]


[[Category:Bank_Lending]]
[[Category:Manage_risks]]
[[Category:Interest_Rate_Risk]]

Latest revision as of 10:24, 18 January 2024

1. Derivatives contracts.

When a contract is in the money, the risk that the other party to the contract fails for any reason, for example bankruptcy.


2.

More generally, the risk to each party to a contract that the counterparty will not meet its contractual obligations, whether they are unable, or simply unwilling, to do so.


See also


Other resource