What will replace Libor?

The US, too, has a preferred candidate chosen by the Alternative Reference Rates Committee (ARRC) of banks convened by the Federal Reserve Board and the New York Fed: the SOFR. But it also has a range of alternatives vying to replace Libor. They include Bloomberg’s Short-Term Bank Yield Index (BSBY), the ICE Bank Yield Index (IBYI) and the Across-the-Curve Funding Index (AXI).

The differences between the rates and the issues involved are well illustrated by the two leading contenders for Libor’s crown: SOFR and the American interbank offered rate (Ameribor), the benchmark developed by American businessman and economist Richard Sandor. 

Too close for comfort

In one sense, all three benchmarks (Libor, SOFR and Ameribor) can do the job. They are all closely correlated, which is perhaps unsurprising, given that they all aim to reflect interest rates. In timing and degree of movements, they track each other closely. There are, however, significant differences. 

Despite not being the favoured solution of the ARRC, Ameribor offers a more straightforward transition from Libor. Set up a decade ago, as an alternative to Libor that better reflected the actual borrowing costs of regional US banks, it shares many of Libor’s characteristics.

It is forward-looking, with the rate given for the next three or six months, for example, and includes an element of credit risk (since it reflects the cost of unsecured lending). 

It is also, like Libor, based on submissions - quotes - by participating banks rather than actual lending. That could mean it is potentially more stable. When the SOFR spiked in 2019 due to a liquidity squeeze, Ameribor did not. The use of submissions rather than simply recording transactions means they can use some discretion to eliminate short-term volatility. 

Of course, it is also that sort of discretion that allowed big UK banks to collude to manipulate Libor. That largely explains why Ameribor was not the choice of the ARRC, along with the fact that Ameribor potentially replicates another of Libor’s problems: a relatively small underlying market. 

Libor rigging was made easier because the market it was supposed to represent (unsecured lending between banks) essentially vanished during the credit crisis and never returned. Libor became, as former Bank of England Monetary Policy Committee member Willem Buiter described it, “the rate at which banks don’t lend to each other”. 

That is not so true for Ameribor, with the underlying market of transactions it reflects worth $2.5bn (£1.8bn) against $500m for Libor. Still, it pales compared with more than $1tn of daily repo transactions that set the SOFR.