LIBOR’s impending demise is a massive financial engineering task


The end is approaching for LIBOR and the financial markets must prepare.

This is the view of Tom Wipf of Morgan Stanley. He heads the Federal Reserve’s Alternative Reference Rates Committee (ARRC), which on Thursday released recommendations on wording allowing contracts linked to the London Interbank Offered Rate (LIBOR) to operate even if the benchmark disappears. Darrell Duffie, professor of finance at Stanford University, also pointed to the risks of abandoning a set of benchmarks that underpin some $200 trillion in dollar-denominated instruments.

“This is the biggest financial engineering project the world has ever seen,” Duffie said during a conference call hosted by fintech firm GLMX on Thursday. He said the risks associated with moving from LIBOR to the Secured Overnight Funding Rate (SOFR) – the ARRC’s preferred alternative – can be mitigated if market participants convert contracts early and regulators announce the date of change “well in advance”.

However, such a transition is by no means assured. While LIBOR suffers from various flaws and has been marred by rigged controversies, the battle to replace it is far from won. The ARRC supports SOFR, but the new benchmark developed by the New York Fed and the US Treasury has yet to prove itself more than a year after its debut. There are also other potential contenders, such as Ameribor and the ICE Benchmark Administration’s Bank Yield Index, and some remain reluctant to get rid of LIBOR.

Wipf, who is vice president of institutional securities at Morgan Stanley, is not among those who see a future for the maligned rate.

“It is no longer a question of if, but when, LIBOR will become unusable,” he said in a statement. He added that most contracts referencing the benchmark do not sufficiently account for its demise, which poses “a huge risk to financial stability and market participants”.

The principles recommended by the ARRC on Thursday relate to so-called fallback language for floating rate notes and syndicated loans, and the group plans to publish recommendations for bilateral commercial loans and securitizations soon. The committee also expects to consult on similar language for consumer products.

Of course, the fallback language is not the only obstacle. Other challenges include the lack of a term structure for SOFR, its lack of a credit component, and the impact of periodic volatility in the repurchase agreement market that underpins the construction of the index. reference.

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