Saron, Sonia, Tonar and Eonia. Behind the Tolkienesque names are the potential candidates to replace Libor, the global borrowing benchmark that underpins more than $350 trillion of financial products, which as of July 27 is being phased out by 2021.
Attaching a time frame to Libor's demise has shifted into sharp focus efforts by financial authorities from Japan to Switzerland to replace the London interbank offered rate. Aside from being mired in fixing scandals, the benchmark has proven increasingly obsolete because of the lack of data behind the daily morning calculation that has established the level set up by the British Bankers Association in 1986.
“They are all trying to come up with what's the best benchmark,” said Priya Misra, head of global interest-rates strategy at TD Securities LLC. “Each hypothetically is in a brave new world, and the transition is not going to be easy.”
Here's a look at what the different regions are considering as a replacement.
The Alternative Reference Rates Committee, a Federal Reserve-sponsored group, recommended replacing Libor with a new, broad Treasury repurchase agreement, or repo, rate, based on the cost of overnight loans that use U.S. government debt as collateral. The rate known as Broad Treasury Financing Rate, or BTFR, is based on about $660 billion in daily transactions.
The U.S. has picked a secured rate, or collateralized by Treasuries, whereas the U.K., Europe and Japan have chosen or are veering toward unsecured, uncollateralized rates.
Phasing out Libor's use by the end of 2021 is probably unrealistic because the new benchmark is not yet established in the U.S., Ruslan Bikbov, a U.S. rates strategist at Citigroup Global Markets Inc., said.
“My expectation is that Libor will continue to exist beyond 2021, it's deeply entrenched in the financial system and it will be difficult to get rid of,” he said.
The New York Fed plans to publish the rate daily, in cooperation with the U.S. Treasury
Department's Office of Financial Research, starting in the first half of 2018.
The Swiss National Bank has been targeting three-month Swiss franc Libor since 2000 and market participants in a working group set up to reform interest rates had “expressed a clear preference to continue using CHF Libor,” according to documents on the bank's website dated October 2016.
With Libor beyond 2021 off the table, that requires a rethink. The SNB will announce an alternative to franc Libor for its monetary policy concept “in good time,” a spokesman for the bank said Thursday.
The working group was already looking at two rates for the local money market: the
secured Swiss Average Rate Overnight, or Saron, and the unsecured Tois, with the latter
to be discontinued by the end of 2017. Bruno Langfritz, the president of ACI Suisse,
an 800-member association of financial market professionals, said on Thursday that
Saron could be a replacement for the franc Libor.
The Bank of England said in April that a swaps-industry working group led by Francois Jourdain, chief compliance officer at Barclays Investment Bank, had proposed replacing the use of Libor in contracts with the Sterling Over Night Index Average, or Sonia. It's a near risk-free alternative derivatives reference rate that reflects bank and building societies’ overnight funding rates in the sterling unsecured market.
The BOE took over administration of Sonia in April 2016. The BOE is in the process of reforming the benchmark and expects to roll out the new version by April 2018.
“The problem with the risk-free rates that are being discussed is that although they
are more reflective of market activity, they are backward looking, based on events
that have already taken place,” Charles Cochrane, a partner at Clifford Chance, said.
“Libor, despite its flaws, attempts to be forward looking.“
Many in Europe already consider Eonia, the Euro Overnight Index Average, to be a viable alternative rate to Euribor, and the European Money Market Institute in April last year published a report on reforming euribor and taking a transaction-based rate.
“In the euro area, they're still working on this process, but for now they're going
to use Eonia. It's uncertain at this point,” Mark Cabana, head of U.S. short rates
strategy at Bank of America Corp. in New York, said. “They're in an odd place because
they want to be able to transition to a transaction-based Euribor, but they've found
that the amount of underlying transactions is insufficient to allow for that. Europe
is in a bit of flux right now.”
A study group on risk-free reference rates has been working on a Japanese yen nearly risk-free benchmark rate since April 2015. It identified the uncollateralized overnight call rate, known as Tonar, calculated and published by the Bank of Japan as the JPY risk-free rate.
With assistance from Zoe Schneeweiss, Dani Burger, Luca Casiraghi, Luca Morreale and Stephen Spratt
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