SOFR Takes Center Stage as LIBOR Heads for the Exit

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SOFR Takes Center Stage as LIBOR Heads for the Exit

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Erin Klepper Joseph Demetrick, CFA Scott Pavlak, CFA
JUN 28, 2021

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History

The London Inter-bank Offered Rate (“LIBOR”) was incepted in 19691 and is a benchmark interest rate intended to represent the average cost at which major global banks offer to lend short-term to one another on an unsecured basis. It provides lenders with a base benchmark that is used in hundreds of trillions of dollars of financial instruments including securitized products, corporate bonds, variable-rate mortgages and student and business loans, to name a few. It also has been incorporated into both performance and risk benchmarks.

LIBOR is regulated by the UK Financial Conduct Authority (“FCA”) in London and is administered by the Intercontinental Exchange (“ICE”). ICE calculates LIBORs for five currencies (USD, GBP, EUR, CHF and JPY) and seven tenors, ranging from overnight to a 1-year term, using a waterfall methodology which relies first on actual transactions and can end with a rate submitted based on “expert judgement”. On a daily basis between 11 and 162 LIBOR panel banks submit where they believe they could borrow wholesale, unsecured funds. In order to calculate an average rate, ICE removes the four highest and four lowest submissions if there are 15-16 contributor banks and removes the three highest and three lowest if there are 11-14 contributor banks.