Bye bye LIBOR

Libor Enters ‘Final Chapter’ as Global Regulators Set End Dates

  • Final fixings for most rates will take place Dec. 31
  • Key U.S. tenors extended after slow progress on transition

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Manipulation by deceitful banks killed LIBOR.

That “news” is a wee bit old.

In any case, it took only a decade, which is lickety-split in financial regulation terms!

I’ve followed this for over a decade. One of those banks defrauded me on a mortgage loan about the same time that they colluded with another bank to manipulate LIBOR. The feds made them send me a small settlement, but my credit score was still trashed for 7 years.

So…it’s dead now? What replaced it?

Okay, sorry, so the short-term LIBOR stuff – SOFR replaced the short-term for U.S.

Most recent info:

In 2017, the U.K. Financial Conduct Authority announced the planned phase-out of LIBOR. In anticipation of the discontinuation of LIBOR and other IBORs, many countries, including the United States, have identified alternative benchmark rates. The Federal Reserve Board and the New York Fed convened a group of market participants, the Alternative Reference Rates Committee (ARRC), which identified the Secured Overnight Financing Rate (SOFR), a rate that measures the cost of borrowing cash overnight collateralized by Treasury securities, as the preferred benchmark replacement for the United States.

As described in detail in our prior client alert,[1] the Proposed Regulations generally provided that a transition from an IBOR to another replacement rate would not cause a taxable event for holders, issuers or counterparties so long as certain requirements were met, including that the fair market value of the contract after the alteration is substantially equivalent to the fair market value before the alteration. The Revenue Procedure provided further guidance on the modification of a contract to include a provision that provides a mechanism for the contract’s reference rate to change in the future from an IBOR to one or more replacement rates (a fallback provision).

There have been various laws/regs passed for longer-term tenors, and that bye-bye date is June 30, 2023

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throwing this in here:

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Grabbing from Matt Levine’s email newsletter (sorry, I don’t know if there’s a link on Bloomberg… as I don’t subscribe on Bloomberg)

dump of the whole thing


The way that global financial markets worked for decades is that trillions of dollars of floating-rate loans and interest-rate derivatives were indexed to Libor, the London interbank offered rate. And the way Libor worked was that someone — at the time relevant to our story it was the British Bankers’ Association[1] — would call up a group of big international banks and ask them “how much would you have to pay right now to borrow dollars for one month,” and they’d answer, and the BBA would take some trimmed average of their answers, and that was one-month dollar Libor. And there were other Libors for other currencies and tenors, computed in the same way.

Most important financial benchmarks do not work this way. The S&P 500 index is not calculated by calling some banks and saying “hey how much would you pay for these 500 stocks” and averaging their answers. The S&P 500 index is calculated based on the last trade of each stock on a public stock exchange. Most indexes are based on actual trades.[2] But Libor was invented because it was very useful, for the floating-rate loan business, to have an index of banks’ unsecured borrowing costs , and unsecured short-term bank debt did not really trade on a transparent public exchange. It traded in an informal, telephone-based interbank market, and the easiest way to find out what trades banks were doing was to call them.

Also, though, they didn’t do trades in every Libor tenor and currency every day. If you wanted to know how much a bank would pay to borrow Danish kroner for two months — which was a real Libor rate — you could not compute that every day based on how much each Libor bank actually paid to borrow kroner for two months that day. Big international banks did not borrow kroner for two months every day. Certainly not every day at exactly the time the BBA called them to ask. But a bank which had borrowed kroner for one month an hour ago, and borrowed dollars for three months five minutes ago, and had a general sense of the curve of its various short-term borrowing costs, could probably give you a good guess at how much it would have to pay to borrow kroner for two months right now. So you could just call it and ask it for that guess. Libor was “the rate at which banks don’t lend to each other,” people said.

The problem is that Libor also became the rate underpinning trillions of dollars of derivatives contracts, and the banks traded those derivatives and built up large positions. And some days it would be good for the derivatives traders to have a low Libor — they had to pay Libor on a bunch of contracts resetting that day, so a low Libor would let them pay less — and other days it would be good for the derivatives traders to have a high Libor. And the derivatives traders realized that, if it was worth $1,000,000 to their bank to have Libor be one basis point lower, then it was worth $200,000 to their bonus to have Libor be one basis point lower, which meant that it was worth calling up their bank’s Libor submitter — the person who answered the phone when the BBA called — and saying “hey mate I’ll buy you a case of Champagne if you submit a lower Libor.” And then the BBA would call the submitter and say “where can you borrow yen for three months,” and the submitter would say “oh 0.525” when in his heart of hearts he knew that the real answer was 0.545, and the BBA would average that in, and 3-month yen Libor would be a smidge lower than it would otherwise have been, and the bank would make money on the derivatives, and the derivatives traders would get their bonuses and the submitter would get his Champagne.

This went on for a while and eventually regulators and prosecutors noticed it and it became a huge huge huge scandal[3] and:

  1. Banks were fined billions and billions of dollars for rigging Libor;
  2. Bank regulators decided to get rid of Libor and replace it with other rates that are harder to rig; and
  3. Various derivatives traders were arrested and prosecuted for rigging Libor.

Point 1 is sort of self-explanatory. In the post-crisis period, if banks do shady stuff and get caught, they pay big fines. Point 2 is quite complicated, because the issues we discussed above — that banks do not actually borrow unsecured in every tenor and currency every day, that the bank funding market is not very transparent, etc. — remain true. The way regulators in the U.S. have addressed these issues is to replace Libor with a benchmark interest rate called SOFR, the Secured Overnight Financing Rate, which reflects the cost of borrowing money for one day secured by Treasury securities. That rate can be calculated based on actual transactions in a liquid market. I should say, regulators are in the slow process of replacing Libor with SOFR; I am talking about Libor in the past tense but that is a bit misleading and it is still in wide use despite being phased out. This is partly for reasons of inertia, but also because using an overnight secured rate raises its own issues for floating-rate lending, etc., which we have talked about before but will not talk about again here.

Here we will talk about Point 3. Some bank traders were prosecuted for rigging Libor.[4] In the U.S., they were prosecuted for “wire fraud,” the crime of lying to people to make money.[5]

There is something a little bit odd about this, if you think about it too hard. The BBA would call up a bank’s Libor submitter and say “where could you borrow yen for three months” and the submitter would say “0.525” when the correct answer was 0.545. But what does it mean to say that the correct answer was 0.545? It does not mean that, as the submitter was saying “0.525,” he was simultaneously entering into a three-month unsecured borrowing agreement to borrow dollars at 0.545%. It means that the submitter’s unbiased best guess about what the bank would pay, right that minute, to borrow a reasonable amount of dollars for three months, was 0.545%, but he said 0.525% due to impure motives.

But of course the submitter’s unbiased best guess was just a guess about a hypothetical question, and for most Libor tenors and currencies on most days that guess would not line up precisely with a contemporaneous actual transaction. And so you could not prove that that best guess — 0.545% here — was “correct,” that it reflected the true answer to the BBA’s question, which was to submit “the rate at which [the bank] could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size just prior to [11 a.m. London time].”[6]

Which means that you also could not prove that the biased, dishonest, Champagne-induced guess — 0.525% here — was false . Could the bank have borrowed yen for three months at 0.525% around the time that the BBA called? I don’t know! Perhaps you could go back and find proof that, right around that time, the bank was looking to borrow yen for three months, and it got a range of offers, and they were all in a range of 0.543% to 0.548% and the 0.525% was a lie. But there is no obvious reason to think that would always be the case; for the most part these were judgment calls and you won’t find a smoking gun proving that the 0.525% was a lie.

More to the point, no one, uh, looked? These cases were brought based mainly on really bad chats . What happened is that prosecutors would investigate a bank’s Libor dealings and find electronic chats like this:

Derivatives trader: Hey what Libor are you submitting today?

Submitter: I think the right number is 0.525%.

Derivatives trader: It would help me out a lot, in terms of profiting on my derivatives, if you would lie and submit a higher number.

Submitter: What if I lied and submitted 0.545%, which is not what I think is the right number?

Derivatives trader: Perfect, I appreciate it, in exchange for your dishonest criminal conduct I will happily pay you a bribe of one case of Champagne.

Submitter: Your bribe is acceptable to me, pleasure doing crime with you.

Derivatives trader: Hope we don’t go to jail!

Submitter: Lol. We should, though, what with the crimes we’re doing!

And then they would charge the trader with wire fraud, and the jury would look at the chats and be like “well yes this sounds like wire fraud” and convict them. Seriously the chats are bad!

Two former Deutsche Bank AG traders named Matthew Connolly and Gavin Black were convicted in a New York federal court of wire fraud for manipulating Libor, and they appealed their convictions, pointing out that there was no proof that the numbers they submitted were wrong . And last week the U.S. Court of Appeals for the Second Circuit agreed with them and tossed out their convictions. Maybe the numbers were right! Who can say? The numbers were necessarily subjective, and anyway the prosecutors forgot to prove they were wrong.

Here is the Second Circuit’s opinion. Connolly and Black traded interest-rate derivatives and cash products, and were accused of pressuring Deutsche Bank’s Libor submitters to submit wrong Libors. Two Deutsche Bank Libor submitters cooperated with the government and testified against them. These were James King and Michael Curtler, who worked on a cash money market trading desk, “borrowing money in the interbank market in order to fund DB’s cash needs.”

The way the cash desk worked is that it would borrow money in the interbank market and then lend it to other Deutsche Bank units to fund their operations; the cash desk would show a real, live, market-based price to those other units. King and Curtler had little spreadsheets (called “pricers”) that they used to decide what that price would be, and they would use that price — the price that they charged Deutsche Bank’s other units — as the basis for their Libor submission. Though sometimes they’d bump it up or down a bit based on their market judgment. From the opinion (citations omitted):

In addition to the above alterations in the pricer, King each day consulted, inter alia, five interbank cash brokers before settling on DB’s LIBOR submissions. He testified that it was logical to “change the [LIBOR submission] rates . . . so that they lined up with what the brokers were predicting” because “the brokers have access to all the banks, they know where we can borrow money or they think they know where we can borrow money.” But King said that while sometimes the rates the brokers were suggesting were all similar, “there [we]re periods when the rates are vastly different”; and then “[we] have to come up with something that we feel is a fair reflection of our rate.” Thus, in submitting LIBOR rates, “some days [King] went with the pricer, some days [he] went with the broker, [and] some days [he] went with the middle.” King testified that he believed that the reference to “reasonable market size” in the BBA LIBOR Instruction–a term the BBA did not define–“gave [him] flexibility as to where [he] could actually submit his LIBOR.”

So he made up a number based on his feel for the market, his own borrowing activity in the interbank market, his own lending activity in the intra -bank market, and calling some interbank brokers and getting their feel for the market.

And then he’d sometimes change that number to benefit the derivatives traders:

King testified that “Gavin Black occasionally asked me to manipulate the rates or to put in a submission that was higher or lower than I would have done to benefit his trading position,” and that “Matthew Connolly on occasion made requests for me to change our LIBOR rates and to benefit the trader’s position.” …

The government also introduced other emails and electronic messages to DB’s LIBOR submitters requesting modifications of the LIBOR submissions in order to benefit DB’s existing trading positions. They included one from Black on May 15, 2008, requesting a low 1-month LIBOR rate because he was “paying on 18 [billion]”; another from Black on February 21, 2005, requesting a high 6-month LIBOR rate; one from Connolly on November 23, 2005, requesting that 3-month LIBOR “be as high as possible”; and an August 12, 2007 email from Connolly stating, "[i]f possible, we need in NY 1mo libor as low as possible next few days…tons of pays coming up overall.” As a result of this last request, King’s DB submission to LIBOR on August 13 was the lowest by any panel bank; and the DB submission on August 15 was four basis points below his estimate of what LIBOR would be.

As Libor-manipulation emails go these are not particularly bad — they don’t mention Champagne, or prison — but they clearly fit the prosecutors’ narrative of “banks submitted wrong Libors to make money on derivatives.” Also it sounds bad. Also the Libor submitters said — on the witness stand, at trial, after signing non-prosecution agreements — that it was bad:

All three cooperators testified that they “knew” the practice of altering DB’s LIBOR submissions to benefit DB trader positions was “wrong” at the time they engaged in it. King stated that “[i]t’s intuitively wrong because we are, you know, as I say, taking advantage of the position. We are benefiting. There was a counterparty on the other side who doesn’t know what we’re doing and is being affected negatively by what we’re doing.” Parietti testified that “even if [LIBOR is] imprecise, hard to estimate, or vague, . . . it’s still wrong to base your submission on your bank’s position instead of information about the cash market.” All three cooperators testified that they never contemporaneously told anyone that they thought the practice was wrong.

But at trial Connolly and Black said, well, but you haven’t proven that the actual rates they submitted were wrong. Maybe Deutsche Bank could have borrowed at those rates! It’s all subjective guesswork anyway, why not. The trial judge didn’t buy it:

The [trial] court stated that “the question for the jury was whether Defendants made LIBOR submissions that reflected something other than honestly held estimates of the rate Deutsche Bank would have accepted in order to borrow funds.” …

The court stated that “whether Deutsche Bank could have borrowed funds at a submitted rate is not dispositive of the falsity of its LIBOR submissions.” It ruled that the government was not required to prove “that Deutsche Bank could not have borrowed funds at a rate submitted to the BBA” in order “to establish the falsity of its LIBOR submissions,” and that “[a]s a factual matter, even if Deutsche Bank could have borrowed funds at a submitted rate, that would not prevent the submission from being false and misleading.” The court stated that even “evidence that Deutsche Bank could have borrowed funds at a submitted rate would not have rendered the Defendants’ statements truthful.”

If the BBA had called up Deutsche Bank and said “hey what is the rate at which you could borrow funds, were you to do so by asking for and then accepting inter-bank offers in reasonable market size just prior to 11 a.m. London time,” and Deutsche Bank had said “0.525%,” and it could in fact have borrowed funds at that rate in the interbank market just prior to 11 a.m. London time , but its submitter incorrectly thought that it would have had to pay 0.545%, then its Libor submission would be “false,” in the sense that the submitter was trying to be dishonest , even though he gave a factually true answer. In fact it didn’t even matter whether the submitter thought the bank could have borrowed at that rate: What matters is that the submitter’s motive was to make money on derivatives rather than to answer the hypothetical question in the usual unbiased way. Or so said the trial judge.

The Second Circuit disagreed:

The precise hypothetical question to which the LIBOR submitters were responding was at what interest rate “could” DB borrow a typical amount of cash if it were to seek interbank offers and were to accept. If the rate submitted is one that the bank could request, be offered, and accept, the submission, irrespective of its motivation, would not be false.

Defendants, of course, had no burden to produce any evidence. The burden was on the government to provide evidence to show that the LIBOR submissions made by King or Curtler after receiving requests from Connolly or Black were untrue. … Yet none of the witnesses testified that DB could not have borrowed a typical amount of cash at the rate stated in any of DB’s LIBOR submissions.

And it noted that actually there were a lot of different rates at which Deutsche Bank could have borrowed:

Most importantly, the one-true-interest-rate theory was also belied by the evidence that loans may have different rates of interest simply because they involve different amounts of principal. King testified that the cash desk would "borrow money every single day,” and that “[t]here were periods where I need to borrow some $20- to $25 billion a day.” He said that “[o]ften it costs you more to borrow more cash than less cash,” and thus loans in various principal amounts could be at varying rates of interest.

Similarly, Curtler testified that “there were days where there would have been a wide range of offered rates.” He said that “[i]f two counterparties were willing to lend to you, I believe I would borrow the cheapest money first”; but “[y]ou wouldn’t borrow one or the other. You would borrow both . . . .” And the BBA LIBOR Instruction does not say which of those two prices should be submitted.

So in theory on any particular day there could have been a wide range of answers to the question “what is the rate at which you could borrow funds in reasonable size,” and if the submitter pushed his number up or down by a few basis points to favor a derivatives trader’s positions, he might still end up with a number in that range — a number that was a factually correct answer to the question.[7]

What a great opinion. Intuitively this makes a lot of sense. Libor asked banks to make up a number. The banks made up numbers. Prosecutors decided in hindsight that some of these made-up numbers were “true” and fulfilled the abstract purpose of Libor, while others were “false” and constituted criminal fraud for which people should go to prison.[8] But all the numbers were made up! They were all guesses, and the distinction between guesses that were good and guesses that were crimes had nothing to do with their correspondence to objective truth; it was just about which guesses came with embarrassing chats and impure motives.

In other ways it is a strange result. Libor is impossible to manipulate , the opinion suggests, or rather impossible to manipulate criminally. Because it was made up, you could make up anything with any sort of nefarious purpose and that would be fine. From the Wall Street Journal:

“In some ways, these reversals underscore what a screwed-up benchmark Libor was to begin with, when you are not being asked to submit actual offers or bids, but just hypotheticals,” said Aitan Goelman, a former director of enforcement for the Commodity Futures Trading Commission, a civil regulator that fined many banks for Libor violations. “It almost begged to be manipulated.”

But what is most interesting to me is not that it might be impossible ever to prove that a bank made a false Libor submission on any given day, but that the prosecutors didn’t try . You can sort of understand where they were coming from. This looked bad. The banks paid billions of dollars in fines for it. If you stand up in front of a jury of normal people and said “these bank traders made a number higher so that they could make more money” the jury will jump up and shout “guilty” before you can finish the sentence. There is a popular narrative of corrupt bankers secretly conspiring to make money by nefarious means, and this story fits that narrative so completely that the prosecutors didn’t even think they had to prove that the bankers were lying!

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text and other features of the article

SOFR Leads Race to Replace Libor as Interest-Rate Benchmark

Sales of corporate loans and derivatives tied to rate have picked up, with Crocs among recent issuers

U.S. companies and financial institutions are starting to settle on a new interest-rate benchmark to replace the troubled London interbank offered rate, which underpins trillions of dollars of financial contracts.

Sales of corporate loans and derivatives tied to the Secured Overnight Financing Rate, or SOFR, have soared in 2022, with borrowers including Crocs Inc. and NortonLifeLock Inc. accelerating the shift away from issuing new debt tied to Libor.

Large U.S. financial institutions, meanwhile, have largely replaced Libor with SOFR—regulators’ preferred choice—for matters such as low-rated corporate loans and derivatives on future debt sales, analysts said.

Secured Overnight Financing Rate (SOFR)Source: FactSet

March 2020’21’2200.250.500.751.001.251.501.75%

Financial authorities started phasing out Libor in 2017 after the discovery that traders at large banks manipulated the rate, which helps set borrowing costs on financial contracts such as mortgages and corporate loans. Starting this year, U.S. banks can’t issue any new debt linked to Libor, while around $200 trillion of existing interest-rate derivatives and business loans tied to the benchmark are set to expire by June 2023.

Regulators have worked with banks to promote broader adoption of SOFR. But the changeover has been slower than some expected, raising concern that an unruly transition would spark legal conflicts and spawn a complex mix of competing benchmarks.

Companies, banks and traders said they picked SOFR—which is based on the cost of transactions in the market for overnight Treasury repurchase agreements—in part because its stability during the Covid-19 pandemic’s market swings demonstrated it is robust enough to support large numbers of financial arrangements.

“There seems to be a clear No. 1 candidate for most deals,” said Amol Dhargalkar, managing partner and global head of corporates at Chatham Financial, a financial-risk adviser.

SOFR has gained traction since a Dec. 31 deadline that prohibited U.S. banks from issuing new debt tied to Libor. U.S. companies in January sold 61 leveraged loans tied to SOFR totaling over $66 billion, according to Leveraged Commentary & Data, a unit of S&P Global Inc. That is up from around $3.9 billion raised across four deals in December.

Shoe maker Crocs said last month it sold a $2 billion SOFR-based leveraged loan to acquire Hey Dude, a casual-footwear brand, for $2.5 billion in a deal that closed last week. Crocs decided to switch to SOFR because “it’s what has been dictated by the market,” said Chief Financial Officer Anne Mehlman.

NortonLifeLock, a Tempe, Ariz.-based cybersecurity software provider, sold in January a $3.69 billion loan to fund its merger with Avast PLC, which is expected to close in April. NortonLifeLock CFO Natalie Derse said primary lender Bank of America Corp. advised the company to switch to SOFR, citing its traction in the market.

Crocs sold a $2 billion SOFR-based leveraged loan to fund an acquisition.

Photo: Scott Olson/Getty Images

NortonLifeLock plans to switch over its remaining $2 billion in Libor-linked debt when it refinances, or pays it off and needs new loans, said Ms. Derse.

“We were OK with Libor,” she said. “If we were in complete control, ​​I don’t know that we would have pushed for a change from Libor.”

The weekly count of derivatives trades tied to SOFR surpassed that of Libor for the first time in the week ended Jan. 21, when the former totaled 8,200 compared with the latter’s 6,815, according to a Chatham Financial review of market data.

Average daily trading of SOFR-based derivatives has grown as well. Over $1.4 trillion of futures and options contracts tied to SOFR changed hands daily during the month through Feb. 15, according to exchange operator CME Group Inc., compared with $237.6 billion in February 2021.

Some small or midmarket businesses are considering other benchmarks, such as the Bloomberg Short Term Bank Yield Index, known as BSBY, and American Financial Exchange’s Ameribor, which they say better reflect lenders’ funding costs and account for the risks from short-term lending.

BSBY derivatives trades totaled 21 in the week that SOFR first topped Libor. A spokeswoman for American Financial Exchange said the electronic marketplace didn’t have a tally of the loans tied to the rate, but said Ameribor is a “true plug-and-play” replacement to Libor.

Some borrowers have held on to Libor, despite the Dec. 31 deadline. Last month U.S. companies launched 10 leveraged loans tied to Libor, seeking to raise $2.9 billion, on top of $9.9 billion from the previous month.

Most of the Libor-linked leveraged-loan transactions this year were so-called add-on loans, in which companies raise additional funds as part of an existing borrowing contract. Companies can also issue Libor-linked debt established before 2022 but set to close this year.

Companies with loans that expire before the June 2023 deadline—when products both existing and new must cease referencing Libor—will likely look into refinancing debt at a SOFR rate, said Jamie Spaman, managing director at the advisory firm and investment bank Stout Risius Ross LLC. Those whose loans don’t expire before then might still wait to evaluate their options.

“It’s still a little bit of wait and see,” he said.