Originally utilized in 1969, LIBOR—the London Interbank Offered Rate—was officially adopted by the British Bankers Association in 1986 as a benchmark rate and has subsequently become the global standard for the rate at which banks lend to one another. LIBOR rates are set by banks daily, with each bank providing the estimated rate at which it expects to borrow funds at a series of maturities (as well as a variety of currencies, which has led to Euro and Yen LIBORs, among others).
The presence of such a robust interest-rate setting process led market participants to adopt LIBOR rates as the basis for a wide variety of financial products. Current estimates place LIBOR as the reference rate in over $200 trillion of active financial contracts in the cash and derivatives markets. LIBOR exposure can most commonly be found in the investment portfolios of banks and credit unions in the form of variable rate mortgage-backed securities and collateralized mortgage obligations.
With no guarantee that LIBOR will continue to be published as of the end of 2021, global financial regulators have drafted plans to facilitate floating rates in the post-LIBOR world. In the United States, the Alternative Reference Rates Committee has chosen the secured overnight funding rate as the replacement for LIBOR, and in our previous article we discussed the differences between the two benchmarks and the challenges to a smooth transition. Fannie Maeand Freddie Mac have recently released a joint playbook and timeline outlining the LIBOR transition, which should help ensure a smooth transition from LIBOR to SOFR.
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