The London Interbank Offered Rate (LIBOR) was a cornerstone of the global financial system for half a century. It was launched in the late 1960s and became the benchmark interest rate for trillions of dollars in worldwide financial contracts. However, its journey has been scarred by scandal and controversy, leading to its eventual phase-out in 2021.

The Birth of LIBOR

LIBOR’s origins date back to 1969. A syndicate of banks led by Manufacturers Trust (now part of JPMorgan Chase) needed a reference rate for a floating rate loan to the Shah of Iran. The British Bankers’ Association (BBA) formalized the LIBOR process in 1986, establishing it as the standard benchmark for interbank lending rates. LIBOR was originally calculated in three currencies: the US dollar, British pound, and Japanese yen.

LIBOR’s Role

It quickly became the reference rate for a wide variety of financial products, including student loans, mortgages and complex derivatives. Its importance grew because it provided a standardized measure of the cost of borrowing between banks, influencing interest rates globally. By the early 2000s, LIBOR was used to set rates for over $400 trillion in financial contracts.

The LIBOR Scandal

The integrity of LIBOR was called into question in 2012 when it was alleged that several major banks had manipulated the rate for profit. It was said that Traders colluded to submit false interest rate estimates and consequently influenced the published LIBOR rates to benefit their own trading positions. This had an impact on the rates in relation to loans, mortgages, and other financial products. It had a severe impact on millions of consumers and businesses. Regulators in the United Kingdom and United States levied approximately $9 billion in fines on the banks involved. This was followed by high-profile criminal cases involving several traders and executives. Tom Hayes, a former Citigroup and UBS trader, was sentenced to 14 years in prison for his role. The scandal highlighted significant flaws in the LIBOR-setting process, including problems with oversight and potential conflicts of interest.

The Decision to Phase Out LIBOR

The scandal prompted an assessment of LIBOR’s transparency and reliability. In 2017, the Financial Conduct Authority (FCA) announced that LIBOR would be phased out by the end of 2021. The decision was driven by several factors:

• Loss of Credibility: The manipulation of LIBOR rates severely damaged its credibility as a benchmark.
• Declining Participation: Fewer banks were willing to participate in the rate-setting process.
• Regulatory Pressure: Regulators pushed for a transition to more robust and transparent processes.

The Transition to Alternative Benchmarks

In response to the phase-out of LIBOR, financial markets began transitioning to other benchmarks. The Sterling Overnight Index Average (SONIA) in the UK, the Secured Overnight Financing Rate (SOFR) in the United States, and the Euro Short-Term Rate (€STR) in the Eurozone emerged as preferred alternatives. These rates are based on actual transaction data, making them less susceptible to manipulation and are referred to as risk-free rates (“RFRs”). The remaining transitional synthetic LIBOR settings were published for the last time on 30th September 2024. It means that all thirty-five LIBOR settings have now ceased. Synthetic LIBOR was a temporary measure to give firms more time to move legacy LIBOR-linked contracts to alternative RFRs.

Nikhil Rathi, CEO of the Financial Conduct Authority, said: “The end of LIBOR is the epitome of a quiet regulatory success, of huge and complex risks unwound diligently over time, including during periods of unprecedented market turbulence. The transition away from LIBOR is one of the most significant events in markets in this generation. It was a task that at times seemed Herculean. Achieving it required coordination between public bodies, across borders and with industry. It shows what can be done through collaboration and with a shared goal. I want to thank everyone who made it happen.”

Conclusion

The end of LIBOR was an important event in global finance. Although it played a crucial role in the financial system for over half a century, its manipulation and the resulting loss of trust meant it had to be replaced. The transition to alternative benchmarks aims to restore confidence and ensure greater transparency. As the financial world adapts to this new landscape, the lessons learned from the LIBOR scandal will continue to shape the future of benchmark rates.