The Daily Update: Libor a trusted friend

There is a big change coming to financial markets at year end as Libor, London interbank offered rate, which is widely used across many currencies and maturities to set contract rates for a wide variety of transactions, is dropped. Other indicators such as the Sterling Overnight Interbank Average rate is the replacement or the Secured Overnight Financing Rate in USD. However, although the change is a few months away traders still prefer to use Libor.

Libor was launched back in 1986, after two years of testing, initially in just three currencies Dollar, Yen and Sterling but since then the use of the rate has been dominant across most currencies. It is thought that over $360 Trillion of financial products are linked to the rates with the Fed estimating that over $223 Trillion is tied to US dollar Libor.

Libor remains by far the dominant rate; on a risk weighted basis it accounted for $23billion of the $26.6 billion in derivative trades in July and on a notional basis 88% of the $127 trillion of interest rate derivatives traded during the same month.

So earlier this week in the US, a joint letter was sent by the US regulators including the Treasury, the Securities and Exchange Commission and the Federal Reserve to the Association for Financial Professionals and the National Association of Corporate Treasurers which said, “We have stressed the importance of reference rates built on deep, liquid markets that are not susceptible to manipulation.” Serious stuff.

Here in the UK the authorities are a little more relaxed as last month almost 60% of trading in the Sterling market was tied to an alternative Libor reference rate.