Quiz: The Transition from LIBOR

This is a draft, shown for review before publication.

4 questions to check your understanding of the chapter “The Transition from LIBOR”. Choose an answer and select “Check answer” to see the answer and explanation. You can also open “Answer and explanation” to see the answer first.

1. Question 1

   What was the main reason it was decided that publication of LIBOR (London Interbank Offered Rate) would stop?

   1. A.Rate manipulation came to light in 2012, and the UK authority had publication stopped within that year
   2. B.Unsecured interbank trading did not grow enough, and the UK authority saw the framework as unsustainable
   3. C.LIBOR was built from rates on secured repo transactions and did not include bank credit risk
   Answer and explanation

   Answer: B

   LIBOR was a benchmark rate: a group of banks selected as panel banks submitted to the administrator the rates at which they would borrow funds unsecured, and the administrator compiled and published the result. After it came to light in 2012 that some panel banks had submitted rates that differed from actual market conditions, efforts were made to reform LIBOR on the view that benchmark rates should be based on actual transactions as far as possible. Even so, the underlying unsecured interbank transactions did not grow enough, and in 2017 the UK Financial Conduct Authority (FCA), which supervised LIBOR, indicated that the LIBOR framework could not be sustained, also pointing out that many panel banks were uneasy about submitting rates. In July of the same year, the head of the FCA said that the FCA would not use its powers to keep LIBOR going after the end of 2021.

   Although the manipulation came to light in 2012, publication continued afterward, and publication by panel banks did not end until the end of December 2021. And because LIBOR was a term rate at which banks borrowed unsecured, it included bank credit risk.

   Learn more: The Transition from LIBOR

2. Question 2

   Among the end dates that the FCA and LIBOR's administrator announced in March 2021, which LIBOR setting was to continue to be published by panel banks until the end of June 2023?

   1. A.3-month yen LIBOR
   2. B.3-month sterling LIBOR
   3. C.1-week US dollar LIBOR
   4. D.3-month US dollar LIBOR
   Answer and explanation

   Answer: D

   LIBOR's administrator is ICE Benchmark Administration (IBA), which set the end dates together with the FCA. Only the overnight and 1-, 3-, 6- and 12-month US dollar LIBOR settings were to continue to be published by panel banks until the end of June 2023. The 1-week and 2-month US dollar settings and all settings for the yen, sterling, euro and Swiss franc ended at the end of December 2021.

   After panel submissions stopped, synthetic LIBOR (LIBOR calculated by a different method using market data rather than panel submissions) was published for some currencies and tenors. The 1-, 3- and 6-month yen settings ran until the end of 2022, and 3-month sterling until March 28, 2024. The 1-, 3- and 6-month US dollar settings ran until September 30, 2024, when LIBOR ended completely. Choosing 3-month sterling confuses the end of synthetic LIBOR with the end of publication by panel banks.

   Learn more: The Transition from LIBOR

3. Question 3

   In its July 2019 public consultation, the Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks narrowed the candidates to replace yen LIBOR to three: TONA compounded in arrears, TORF and TIBOR. Which statement about the three is correct?

   1. A.TIBOR is set at the start of the period and includes bank credit risk
   2. B.TORF is set at the start of the period and includes bank credit risk
   3. C.TIBOR is set just before the interest payment date and includes bank credit risk
   4. D.TONA compounded in arrears is set at the start of the period and does not include bank credit risk
   Answer and explanation

   Answer: A

   TONA is the Tokyo Overnight Average Rate, TORF the Tokyo Term Risk Free Rate and TIBOR the Tokyo Interbank Offered Rate. The three differ in when the rate is set and whether it includes bank credit risk. TORF and TIBOR are set at the start of the period, like LIBOR, while TONA compounded in arrears is set just before the interest payment date. Only TIBOR includes bank credit risk.

   TORF is set at the start of the period but does not include bank credit risk. The rate set just before the interest payment date is TONA compounded in arrears, not TIBOR. Choosing in this way among several rates with different features to suit the nature of each trade is called the multiple-rate approach.

   Learn more: The Transition from LIBOR

4. Question 4

   When a fallback provision switches a contract referencing LIBOR to a successor rate, why is a spread adjustment added to the base rate (the fallback rate)?

   1. A.Because calculating the successor rate takes effort, and the cost of that work needs to be passed on to the borrower
   2. B.To make the rate after the switch equal to synthetic LIBOR, so that the rate can also be used in new contracts
   3. C.Because LIBOR and the fallback rate differ, so switching without adjustment transfers value between the parties
   Answer and explanation

   Answer: C

   A fallback provision writes into the contract in advance that the referenced rate switches to a successor rate on the day LIBOR ends. There is usually a gap between LIBOR and the fallback rate. Switching without adjustment could cause a "transfer of value," with one party gaining and the other losing, so the gap is adjusted with a spread adjustment to keep the transfer as small as possible. For yen loans that use TONA compounded in arrears, the successor rate is TONA compounded in arrears plus a spread adjustment.

   The spread adjustment is not meant to pass the cost of the work on to the borrower; it adjusts for the gap from LIBOR. Synthetic LIBOR was a safety net for contracts that were truly difficult to transition (tough legacy contracts) and could not be used in new contracts.

   Learn more: The Transition from LIBOR