What is LIBOR? | The Big Explainer | Refinitiv - YouTube

So the spectrum of the LIBOR based  instruments is very, very, very wide, and  

a total notional of LIBOR instruments is around  300 trillion. So it's it's huge. It's massive.

Welcome to The Big Explainer.  

Funding markets are essential to the  financial plumbing of the global system.  

Businesses and consumers across  all parts of the economy will  

probably have loans or mortgages that were  referenced off LIBOR in its various forms.  

LIBOR is a benchmark of which an estimated 300  trillion dollars worth of products are referenced.  

That's the equivalent of over four  times the size of the global economy.  

This is a huge market and a key, but also normally  mundane component of the financial system.  

Funding markets were, however, brought into  sharp focus during the financial crisis of 2008.  

LIBOR was then hit by a price fixing scandal that  has influenced an overhaul of this massive market,  

with the changes to be implemented  by the end of next year.  

So what is LIBOR? I asked Alex Hardouin,  Head of Rates at Refinitiv for an overview.

LIBOR just refers to London Interbank  Offered Rate, so it's meaning of rates,  

it is representative of the rates at which large  institutions, large banks could fund themselves in  

selected currencies for certain tenors. So it has  been there for almost since the 80s, pretty much,  

it is across five currencies. It was, it is  still based because it is still active, that's  

what you have to that people have to understand.  It is based on submission's provided by 20 banks.  

So normaly these submissions are intended to  reflect where the market is. The thing is that  

back in 2013, 2014, there has been some  manipulations of those submissions,  

meaning that the banks that were submitting LIBORS  were submitting a rate, which was not the rate  

effective on the market, but the rates delivered  of the rate at which they want that rate to be.  

So that has caused a big issue in the market  that everybody talked about at that time.

LIBOR is a generic name in reality,  

there are a number of different  IBORS for different currencies.

I mentioned five currencies, so  the L in LIBOR stands for London,  

but IBOR is used of course in the UK, in the US,  

in the Eurozone, there is an equivalent called  Euribor, which is the euro version of the LIBOR.  

And then you have LIBOR in a lot of different  geographies. So when we are talking about LIBOR  

transition is not only the LIBOR per-se, but it's  all those IBOR type risk free rates. So you will  

very often hear about LIBOR transition, IBOR  transition or transition to new risk free rates.  

And those risk free rates are very different from  the LIBOR. I mentioned that there were various  

tenors which allowed to build term structure from  overnight. Spot one week, one month, two months,  

three months, six months, one year. So pretty much  the near end of the curve was there with LIBOR.  

Most of those ex-IBOR rates are now replaced by  overnight index rates, which are daily rates, and  

those rates are very different in nature. So LIBOR  was a risk free range, which is considered to be  

an asset risk free with with no premium on top of  it. Overnight is the same, it's also considered  

to be risk free rates, is used as a benchmark  by the market so that's why it's so important.  

And the new risk free rates are overnight based.  So for US, it's now called SOFR, for Sterling,  

it is SONIA, for euro, it is ESTA for Japan  LIBOR, it is TONAR for Swiss, LIBOR it is SARON.

This funding market is a key  part of the plumbing because  

of the size of the market and the wide  range of products that it influences.

So it's important because you have derivatives  like interest rate swaps, basis swaps  

OIS, cross-currency basis swaps, swaptions,  

caps and floors. So the spectrum of the LIBOR  based instruments is very, very, very wide.  

And a total notional of LIBOR  instruments is around 300 trillion.  

So it's it's huge. It's massive. So that's  why it's a big, big challenge for all market  

participants. And it will be the number one topic  in 2021 for anybody in the fixed income market.

One of the key differences between the  new reference rates and the old IBOR rates  

is that the new reference rates are based  off actually traded overnight rates,  

which are far more liquid and therefore  more accurate than the old IBOR rates  

where the regulators were concerned that these  were no longer liquid enough for this key market.  

Alex focuses on OIS or overnight index swaps.  This is an interest rate swap where the reference  

rate is an overnight rate, but the term of  the swap is fixed over a specific period.

So the first very important data that people need  is the fixing itself. So which means the SOFR  

rates for US, for instance, or the SONIA rates or  the SARON or the TIBOR or ESTOR for euro. You need  

that fixing. So what we have, we see liquidity  in the overnight index swaps. So we will see a  

lot of SOFR OIS, SONIA OIS, ESTOR. We'll we see  a bit of liquidity coming on TIBOR and SARON,  

but are less developed. I would say that SONIA  is the most developed then SOFR then ESTOR.  

You find some short term interest rate features  from the values exchanges and then you will find  

derivatives like the basis swaps SOFR against  LIBOR, for instance, typically, which is  

something quite important to monitor because  you see the difference between SOFR & LIBOR.  

Also to price existing LIBOR deal is the asset  that, you know, there's a need to have a fallback  

rate. Or fallback language to to to transfer  existing LIBOR deals into the new risk free rates.  

So we will display that rates very, very soon  on our offering. There's also something very  

important and on top of those either broker  data or fixing data or fall-back. We are also  

calculating curves and curves are really, really  important in order to price those derivatives.  

So we have a SOFR base curve and  that curve is very accurate because  

now that we see liquidity on the OIS SOFR market,  we are getting trades executed on trade web, which  

is partially owned with by Refinitiv. So it means  that we can have US SOFR OIS on our terminals.  

And out of that, we create a very, very  accurate SOFR curve that then you can use  

to either discount cash flows of existing  rates, derivatives, and that is very important,  

you know OIS discounting it's also been  something very popular since few years,  

because the logic behind is that banks or anybody  in a swap needs to discount using the most  

the most liquid funding source. And OIS is a very,  very liquid funding source. And we have those  

curves OIS curves built for SOFR, ESTOR, SONIA  and it's building up on SARON and TIBOR. And then  

what we can do with those curves is that you can  price, meaning you can create any kind of swap.  

So we have tools in, for instance, in EIKON  terminals such as a Swap Pricer or in Excel,  

we have Excel function where people can value  swaps. If you want to enter into a new swap,  

being spot starting for starting or calculate  the net present value of an existing swap,  

you can use those curves to  project the future cash flows.

Because the new rates are references  of liquid overnight rates,  

they don't have forward looking prices.  The old IBOR rates had a term structure  

or prices long different maturities such as  one month to three months. New term structures,  

therefore, will now need to be calculated for the  new reference rates from these overnight rates.

I mentioned in the introduction  that the new risk free rates are  

backward looking, whereas  LIBOR was forward looking. So  

you don't have that element of term structure  such as you had in the past with LIBOR,  

where you had an overnight, the next one month,  three months, six months, and you could derive  

a curve directly from the LIBOR. You don't  have it anymore with with SOFR. So that's why  

we use the OIS SOFR contributions that we are  getting from either tradeweb or the interdealer  

brokers. But we are also calculating term rates  for customers, even for somebody who would need to  

enter into a mortgage, for instance, which used to  be against LIBOR three months. Now you don't have  

that three months point anymore. So what we are  building now is the what we call the term rates.  

So Refinitiv has submitted SONIA term rates and we  are working on SOFRt term rates ESTOR term rates  

to have that element also of tenors and calculate  term rates forward looking based on compounded  

OIS rates. So that's also something very important  for the marketplace, as well as providing  

calculation tools. So people need to be able to  calculate their forward cash flows. So we are  

also working on an Excel spreadsheet and little  app in EIKON that calculates compounded rates,  

which is very important on any on any dates,  meaning that even if you have a nonstandard swaps,  

you will be you will be able to calculate your  cash flows using the compounded rate calculator.  

So that's the things we are working on, and the  thing with the element we think are needed by  

the market for the numerous conversations  we are having with market participants.

Many regulators are focusing on a transition to  take place over the next 12 months, which doesn't  

leave much time for both financial firms and their  customers to adapt to the new reference rates.

From the discussion we've had with all  sorts of customers from buyside corporates,  

large sell side, everybody now gets ready for the  transition, meaning that everybody needs the data.  

I've just mentioned the valuations, the tools are  all there. And and as as I said, introduction that  

will be the number one priority in 2021 for a lot  of people because LIBOR is meant to stop in 2021.  

So then you will need to use the alternatives,  risk free rates and the new risk free rates  

and the associated data and and  the tools that we are providing.

This is a very large market that is about  to change. Some have argued that these  

funding numbers are the world's most important  numbers because so much of our financial system  

is based upon them. But the transition will  involve considerable cost for financial firms.  

Some products may reference obsolete  numbers after the transition has been made.  

Communicating these changes will be a significant  challenge. The old IBOR is embedded in companies  

operating models, and transition may lead to  unexpected windfall losses and gains. The whole  

financial framework will be grappling with these  significant changes over the coming 12 months.