Driven by the G20 and the Financial Stability Board, major initiatives are under way to reform interest rate benchmarks and move away from Interbank Offered Rates (IBOR) to overnight near risk-free rates.
Since 1986, the London Interbank Offered Rate (LIBOR) has been one of the most important interest rates in the world and is referenced as the standardized benchmark for many financial instruments such as interest rate derivatives (swaps, options, Eurodollar futures), floating rate notes, business loans and securitized products (mortgages), and government bonds amounting to almost $350 trillion in outstanding notional. In response to concerns about market manipulation and as well as continued decline in the degree to which banks fund themselves in the London interbank market, global regulators have selected alternative reference rates to LIBOR.
In the United States, the Alternative Reference Rates Committee (ARRC) has been tasked with two primary goals—to identify an alternative reference rate to replace LIBOR, and to develop a market strategy to make the transition. In April 2018, the Federal Reserve Bank of New York (NY Fed) began publishing the Secured Overnight Financing Rate (SOFR), a new benchmark rate intended as a replacement for LIBOR.
Milliman’s white paper titled “The end of LIBOR” discusses the implications of the transition away from LIBOR, which will be an expensive and complicated endeavor that will take several years to achieve. While much uncertainty remains, insurance firms should plan for LIBOR cessation by first identifying LIBOR exposure on a product-by-product basis, reviewing fallback language in legacy contracts and evaluating systems readiness.