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Markets' continued use of Libor is financial stability risk, global monitor says

Global markets' continued reliance on Libor poses risks to financial stability, said the Financial Stability Board, as it called for "significant and sustained efforts" to move away from use of the benchmark interest rate by the end of 2021.

Libor, the London interbank offered rate, is based on the rate that banks lend to each other together with the expert judgement of bankers, and it underpins trillions of dollars of contracts from derivatives to credit cards and home loans. It was discredited after numerous banks were fined and bankers imprisoned for manipulating it.

While the actual transactions it is based on have declined dramatically, financial regulators worldwide want markets to discontinue using it and move towards risk-free rates instead. Risk-free rates are based on the actual cost of bank borrowing for overnight deposits.

End-2021 goal

The FSB, which is made up of regulators and central bankers from the world's biggest financial centers, wants the transition to happen by end-2021 but it is still unclear when exactly the rate will cease to be either published or regarded by regulators as properly representative.

"FSB members are committed to transitioning to more robust financial benchmarks," said Andrew Bailey and John Williams, co-chairs of the FSB Official Sector Steering Group.

"It is essential that both firms and national authorities around the world take steps now to ensure a smooth transition. As a matter of priority, authorities should discuss with financial institutions, and financial institutions with their clients, the transition process and agree on the steps needed."

The FSB said that, although there has been good progress away from Libor and other interbank offered rates and towards risk-free reference rates in many derivatives and securities markets, loan markets showed less signs of change.

"There may be $8 trillion in loans tied to U.S. dollar Libor that are originated outside of the U.S., and there are a number of other cross-border exposures to U.S. dollar Libor through derivatives, including cross-currency basis swaps, and other securities," it said.

Sofr, Sonia

However, the volume of overnight Treasury repo transactions underlying the preferred U.S. benchmark, Sofr, the secured overnight financing rate, now exceed $1 trillion on a daily basis, the FSB said.

To ease adoption of Sofr in consumer and other cash products, the Federal Reserve Bank of New York has stated that it plans to publish 30-, 90-, and 180-day compound averages of Sofr in the first half of 2020 as well as a "Sofr Index" that would allow market participants to calculate compounded Sofr rates over any period of time.

In the U.K., where regulators' preferred risk-free rate is Sonia, the sterling overnight index average, 33 different banks, sovereigns, and supranational agencies issued floating rate notes referencing compounded Sonia, with a total value of £35 billion, over the past year. Use of compounded Sonia has become the market standard for sterling securitizations, said the FSB, with more than £15 billion of publicly distributed issuance since April 2019.

The FSB said it will conduct a survey of exposures to Libor and supervisory measures being taken to address benchmark transition issues, and will deliver a report on the remaining challenges to benchmark transition to the G20 Finance Ministers and Central Bank Governors in July 2020.