Interest rates - reference rates.
Originally, but no longer, an acronym for “London Inter-Bank Offered Rate”, LIBOR was a formal, regulated, benchmark short-term interest rate, now substantially replaced.
It was compiled and published on business days in London, normally at 11.55 am, by ICE Benchmark Administration Limited (IBA). It referred to a series of daily unsecured simple-interest-rate benchmarks in several currencies and maturities.
LIBOR provided an indication of the average rate at which its contributory Panel Banks could obtain wholesale, unsecured funding for a given period, in a given currency. Looking at the overall market, one would expect that some banks could fund at rates below the relevant LIBOR, and many would fund at higher rates.
It is sometimes written 'Libor'.
LIBOR was often referenced in derivative, bond and loan documentation, and also in documentation for a number of consumer lending products. LIBOR was also used as a gauge of market expectation regarding central bank interest rates, liquidity premiums in the money markets and, during periods of stress, as an indicator of the general health of the banking system.
Dates for cessation of LIBOR
- 31 December 2021 - all LIBOR settings either ceased or are no longer representative for Sterling, Euro, Swiss Franc and Japanese Yen LIBOR settings in all maturities, and US Dollar LIBOR 1-week and 2-month maturities.
- 30 June 2023 - all LIBOR settings either ceased or are no longer be representative for US Dollar Overnight, 1-month, 3-month, 6-month and 12-month maturities.
- Wind-down of LIBOR
- "We are proposing to require LIBOR’s administrator, IBA, to continue to publish the 1-, 3- and 6-month US dollar LIBOR settings under an unrepresentative ‘synthetic’ methodology until end-September 2024.
- After this, publication would cease permanently.
- For sterling LIBOR, we intend to continue to require IBA to publish the 3-month synthetic sterling LIBOR setting until end-March 2024, after which it will cease permanently.
- The effect of these announcements and proposals is that the final LIBOR publication would be end-September 2024:
- the 3 synthetic yen LIBOR settings will cease at end-2022
- the 1- and 6-month synthetic sterling LIBOR settings will cease at end-March 2023
- the overnight and 12-month US dollar LIBOR settings will cease at end-June 2023
- the 3-month synthetic sterling LIBOR setting will cease at end-March 2024
- the 1-, 3- and 6-month synthetic US dollar LIBOR settings would cease at end-September 2024 (proposed) "
- Further consultation and announcements on the wind-down of LIBOR - Financial Conduct Authority - 23 November 2022.
Definitions of LIBOR - Waterfall methodology
For each currency and maturity, LIBOR was calculated as the truncated average of rates provided by each of a panel of banks that submitted for that currency. A panel varied from 11 to 16 banks.
During the process of transitioning to the Waterfall methodology (discussed below), some panel banks were making LIBOR submissions using the LIBOR Submission Question (see below) while others were making LIBOR submissions using the Waterfall methodology. Following the successful completion of the transition, announced on 1 April 2019, all panel banks made LIBOR submissions under the Waterfall methodology.
From mid-2018 a newer, uniform determination methodology, the “waterfall methodology”, by which each contributing bank calculated the rates it submitted, was progressively introduced. The underlying interest - the market or economic reality that the benchmark sought to measure - remained the same. The newer methodology was widely consulted upon from 2015. The adopted waterfall methodology was set out by IBA in its LIBOR Evolution Report of April 2018, https://www.theice.com/publicdocs/ICE_LIBOR_Evolution_Report_25_April_2018.pdf. Appendix one to this Report includes the LIBOR Output Statement that effectively defined the new LIBOR.
The “waterfall” methodology referred to the three bases for a bank’s rate submission. The idea of a waterfall of methods, with the first practical method being used in any case according to the information available, was included in the Wheatley Review of LIBOR, the UK government appointed 2012 enquiry into LIBOR following the scandal that became public from 2008 (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/191762/wheatley_review_libor_finalreport_280912.pdf). The concept is also used in the EU Benchmarks Regulation.
The three bases in the LIBOR waterfall were:
- Level 1: Transaction-based
- Level 2: Transaction-derived
- Level 3: Expert judgement
There were detailed provisions for these in the Roadmap Report and in the LIBOR Code (see below). Particular attention was devoted to ensuring that “Expert judgement”, Level 3, was “suitably framed” with contributing bank processes having to be agreed with the Administrator, IBA.
In summary, the new methodology was more rooted in actual transactions as far as possible. Using less “judgement” that could involve a (possibly unconscious) element of “smoothing”, contributed rates were expected to vary up and down more by small amounts each day. And, recognising the reality that banks short-term-fund in the wider money-markets now, rather just inter-bank, the range of transactions considered was widened and this could mean small rate differences.
Following the successful completion of the transition period, LIBOR became, for each currency/maturity combination, the rate output as the arithmetic mean of the relevant panel banks’ waterfall-methodology based submissions, excluding the highest and lowest quartile of submissions. Each panel bank’s submission carried an equal weight, subject to the trimming.
The LIBOR Submission Question
The LIBOR methodology introduced in 1998 and phased out by end Q1 2019 stipulated that LIBOR panel banks submit their estimate of the all-in, simple interest rate (including credit premium and liquidity premium) that answered the following submission question for each currency/maturity: “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?” We can note that LIBOR was thus, since 1998, a hypothetical transaction rate and not an "offered" rate as such. On introduction in 1986, however, it was, using the question “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?” More of the earlier history of LIBOR is set out below.
LIBOR was administered and published by ICE Benchmark Administration Limited (IBA) but prior to 1 February 2014 by the British Bankers’ Association (the BBA).
LIBORs were published by ICE Benchmarks for:
- CHF (Swiss franc)
- EUR (euro) (do not confuse with Euribor)
- 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.
For each currency LIBOR was published for seven tenors: Overnight/Spot Next, 1 Week, 1 Month, 2 Months, 3 Months, 6 Months and 12 Months.
From 1 April 2013 the compilation and distribution of LIBOR rates was a regulated activity under the UK’s Financial Conduct Authority (FCA). From the same date, LIBOR became a “specified benchmark” under the Financial Services and Markets Act. The FCA Handbook (MAR) covers Benchmarks in MAR 8, with requirements for submitters (MAR 8.2) and administrators (MAR 8.3). UK Market conduct and fraud provisions continued to apply to LIBOR contributors.
The UK-specific regulation of compilation and distribution of LIBOR rates was phased out as the EU Benchmarks Regulation (BMR), https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32016R1011 came into effect in stages, starting from 30 June 2016. While it generally applied from 1 January 2018, older benchmarks such as LIBOR came fully under the Regulation by January 2020. IBA was authorised under the BMR on 27 April 2018. LIBOR became a critical benchmark for the purposes of the BMR from 29 December 2017.
The idea of a panel of reference banks
The idea for averaging short-term funding rates taken from a panel of banks to use in a syndicated revolving loan is attributed to Minos Zombanakis of Manufacturers Hanover Bank in London. He “devised a formula whereby a select group of ‘reference banks’ within a syndicate would report their cost of funds to the agent bank shortly before the rollover date, and the weighted average, rounded to the nearest 1/8th per cent plus a ‘spread’ for profit, would become the price of the loan for the next period.” The idea was used contractually in 1969 in a syndicated bank loan to the Shah of Persia.
The rate produced from applying the idea became known as the London inter-bank offered rate (LIBOR). The phrase itself had been used since the mid-1960s.
The idea was first used for debt in 1970 in a floating rate note at the suggestion of Evan (“Van”) Galbraith for the first Euro-currency (US dollar) floating rate note. This note was organised by Warburgs and Bankers Trust International in London for the Italian oil company ENEL."
Separate definition and calculation of rates by agent banks from inputs sought from groups of banks specified for each contract as new deals were entered into eventually proved burdensome. Development of over-the-counter interest rate swaps and forward rate agreements, each uniquely referencing inter-bank rates in some way, made the problem larger.
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. This was when use of a standard panel of banks and excluding the outlying quartiles of contributed rates from the calculation of the average were introduced. The rate started with German marks, United Kingdom pounds sterling, and United States dollars.
LIBOR’s ready availability eased the further growth of the interest rate derivatives and syndicated loans markets. It was soon used for many purposes.
On 1 April 2013 Financial Conduct Authority (FCA) was formed to take over as the UK’s financial services regulator from the Financial Services Authority (FSA) and, on that day also, both compilation and distribution of LIBOR rates and contribution of rates for use in compiling LIBOR rates became regulated activities. Of course, even before then, the activities had been subject to normal fraud laws and to the FSA’s market abuse principles. It is under these provisions that the UK’s punitive actions against those involved in manipulating LIBOR in the early 21st century were taken (see below).
On 1 February 2014, the BBA was replaced as Administrator of LIBOR as the Wheatley Review of 2012 had recommended (see above). ICE Benchmark Administration Limited (IBA) took over. IBA made no immediate changes to the LIBOR process but it became 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, later in 2014 []. Since then IBA has invested significantly and put in place new governance, oversight, controls and technology to strengthen the benchmark.
In late 2014, IBA published a consultation  in the form of a Position Paper on the Evolution of ICE LIBOR that proposed a number of changes to LIBOR. Further consultations followed and the transition to the evolved waterfall methodology (see above) had been completed by 1 April 2019.
Early 21st century controversy
During the early stages of the global financial crisis in late 2007 and especially after the 2008 collapse of Lehman Brothers, concerns began to be raised about the good faith of rates contributed by banks for use in the compilation of LIBOR (and other ~IBORs). The first publicly available reference to this that has come to attention is in the minutes of the Bank of England Sterling Money Markets Liaison Group of Thursday 15 November 2007 – no longer on the Bank of England website but in the National Archive. Minute 2.1 starts: “Several group members thought that Libor fixings had been lower than actual traded interbank rates through the period of stress.”
As the scandal developed, 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
- particularly following the collapse of Lehman Brothers in 2008, banks tried to disguise the market’s falling confidence in the banks’ individual credit standings by submitting lower rates than the actual rates at which they were being offered and accepting funds.
Enquiries in the US and the UK and other countries resulted in administrative and criminal action against some banks and brokers and individuals. Also, in the UK, Martin Wheatley produced a report on the future of LIBOR recommending a change of administrator, governance and oversight and, eventually, methodology (see above).
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 first benchmark specified was BBA LIBOR (now ICE LIBOR). The approach to regulation was set out in a Policy Statement PS13/6 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 July 2013 the FCA first approved the British Bankers Association’s April 2013 Code of Conduct for Contributing Banks to LIBOR as Industry Guidance – following which gives regulated bodies some protections  (BBA Trent Ltd is the re-named BBA LIBOR Ltd). The BBA gave up responsibility for LIBOR to ICE Benchmark Administration as of 1 February 2014. IBA initially adopted the text of the BBA Code but has made changes since (see above).
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 (now ICE Swap Rate), WM/Reuters 4 pm London Closing Spot Rate, London Gold Fixing, LBMA Silver Price and ICE Brent.
Alternative rates projects
Banks had very substantial administrative penalties and fines imposed on them. The regulatory and reputational risks to banks from staff misconduct as they operated it in the early 2000s had made them reluctant to contribute rates. Cessation of the publishing LIBOR rates was seen as a threat to financial stability, given the high nominal values referencing the rate. Furthermore, there was concern at the limited number of transactions underpinning some LIBOR currency/maturity combinations given the changes in bank funding and in their capital and liquidity regulation.
The FCA has power to compel contributions under UK law and similar powers under the BMR. It secured banks’ agreements to contribute rates until the end of 2021 after which it will not use its powers of compulsion for LIBOR. The changes made to LIBOR by IBA, among other effects, had the objective of significantly reducing the opportunities for rate manipulation and so reducing the risks to banks from contributing rates.
Over time, a reformed SONIA has superseded LIBOR as the primary sterling benchmark rate, particularly, and to start with, for those purposes not needing to include maturity and bank credit premiums. Similar relatively risk-free rates have been developed for the other LIBOR currencies. The ACT and the LMA published a guide to the new rates under development, available at https://www.treasurers.org/ACTmedia/ACT_LMA_Future_of_LIBOR_Guide_0318.pdf.
- Base rate
- Benchmarks Regulation
- Cost-plus loan pricing
- Day count conventions
- Effective annual rate
- euro LIBOR
- Financial Conduct Authority
- Floating rate note
- Forward rate agreement
- ICE Benchmark Administration
- ICE LIBOR
- ICE Swap Rate
- JPY LIBOR
- London InterBank Offered Rate
- New York Funding Rate
- Official Bank Rate
- Rate switch
- Reference rate
- Simple interest
- Synthetic LIBOR
- TED spread
- Total return swap
- Transition risk
- USD LIBOR
- Further consultation and announcements on the wind-down of LIBOR - Financial Conduct Authority - 23 November 2022
- Changes to LIBOR as of end-2021 - Financial Conduct Authority
- LIBOR rates from 1986 on, including for discontinued rates (Available from the Archival Economic Data maintained by the St. Louis Federal Reserve Bank (ALFRED) - select LIBOR Rates from Categories.)
- The Story of Minos Zombanakis: Banking Without Borders, David Lascelles, Economia Publishing, 2011
- Speech, The Early Eurobond Market, Peter Spira, Chairman of Advisory Board, AGI, to the International Capital Market Association Eurobond Dinner, June 2013, https://www.icmagroup.org/assets/documents/About-ICMA/Eurobond-anniversary/Eurobond%20dinner%20speech%20Peter%20Spira%20June%202013.pdf, and remarks to John Grout, Policy and Technical Director of the Association of Corporate Treasurers, August 2014, by David Clark, Chairman of the Wholesale Markets Brokers' Association, who worked in 1970 for BTI on the transaction and was present at the signing and has approved citation here.