Liberating the World from LIBOR: Implications for Non-Cleared Derivatives
11 Pages Posted: 16 Aug 2017
Date Written: August 11, 2017
Historically, the use of benchmarks, including LIBOR, in non-cleared over-the-counter transactions has been unrestrained. This lack of regulatory consideration is misaligned with the dominance of LIBOR in the over-the counter derivatives trading, as well as with a massive use of non-centrally cleared derivatives for hedging and speculation. Concerns over unprecedented use of LIBOR reached its peak when the benchmark manipulation became a centerpiece of several litigations involving high-profile financiers. In response to the pitfalls of the scandal-ridden LIBOR, in June this year the Alternative Reference Rates Committee recommended that market participants replace LIBOR with the broad Treasuries repo financing rate. The recommendation to gradually transition to a new risk-free rate was the first attempt to resolve problems surrounding the tainted benchmark on the national level in the US.
This article discusses legal implications and risks around replacement of LIBOR in derivatives’ space. In particular, it contends that an abrupt switch from LIBOR to its risk-free alternative would result in a need to renegotiate a new benchmark, as well as remediate (or “repaper”) and collateralize millions of derivatives trades, which altogether may pose a significant threat to the industry. The article also voices concerns over calls to abandon LIBOR in a relatively short timeline, concluding that a halt to LIBOR would create a substantial repapering burden and additional margining costs for the entire market of non-centrally cleared derivatives.
Keywords: LIBOR; OTC Derivatives; Non-Cleared Derivatives; Interest Rate Swaps; Margin Rules; Variation Margin
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