Understanding IBOR rates
Interbank offered rates (IBORs) are interest rate benchmarks used for a broad range of financial products and contracts.
The majority of IBOR rates will cease to exist by the end of 2021. This means all benchmarks falling under the IBOR umbrella, including the prominent London Interbank Offered Rate (LIBOR), will soon be phased out and replaced by alternative rates.
What is LIBOR?
Since the 1980s, LIBOR was viewed as the benchmark interbank lending rate used to calculate the rate at which banks would offer short-term loans to each other. Until the 2008 financial crisis, LIBOR was seen as the gold standard for measuring the health of the entire global financial system.
Why the change?
Regulators have expressed concerns about the reliability and sustainability of IBORs. Stringent liquidity rules brought on by the 2008 financial crisis, coupled with LIBOR’s loss of credibility due to scandals and its part in the crisis, saw IBORs becoming less attractive for short-term, unsecured interbank lending.
This led to a significant decline in the interbank unsecured funding markets in the last decade, as well as a lack of liquidity - leading to a market which is not adequately representative, prompting regulators to shift their preference towards Alternative Reference Rates (ARRs).
What are they switching to?
IBOR users will be switching to Alternative Reference Rates (ARRs). ARRs are based on actual overnight interest rates in liquid wholesale cash and derivative markets – making them more robust and less volatile than IBORs.
Since ARRs are risk-free rates, they don’t incorporate the credit risk that is inherent in the calculation of IBORs, which are based on interbank lending over longer time periods.
Each currency has its own alternative reference rate as follows:
How are we adjusting for this change?
To compensate for the missing credit risk, we will be adjusting the ARRs by the one-month spread adjustment proposed by the International Swaps and Derivatives Association (ISDA).
How will the switch affect your trading?
We’ve used IBORs for the calculation of overnight funding charges on index and share positions. From 25 September 2021, IBORs will be replaced by an ARR and a spread adjustment, meaning you’ll be charged fees according to the adjusted ARR benchmark +/- an IG admin fee.