LIBOR, the London Interbank Offered Rate, is the average of the estimated rates leading banks in London would be charged if they were to borrow from other banks. It is a theoretical rate and not based on actual transactions but it has served as a reference rate for trillions of dollars of floating rate securities, mortgage agreements, business loans and personal loans since 1986.
Around ten years ago, it suffered from a series of rigging allegations. Rates which were fed into the daily calculation had not been based on actual transactions. Some subjectivity was allowed, which left the door open to questionable practices.
In a 2017 speech made by the Financial Conduct Authority’s Andrew Bailey regarding the future of LIBOR, an argument for the replacement of LIBOR with a reformed version of Sterling Over-Night Index Average (SONIA) was laid out. SONIA was selected as the replacement index shortly afterwards.
The new version of SONIA is a weighted average rate of all unsecured overnight sterling transactions brokered in London. It will not do away with LIBOR immediately; LIBOR will last until 2021 in order to give banks and other holders of contracts time to transition. After all, there are trillions of pounds of contracts still referenced to LIBOR.
However, the transition is beginning. Just this week, Lloyds raised £750 million via the issue of floating rate covered bonds. The issue by Lloyds comes three months after the European Investment Bank (EIB) raised £1 billion through the issue of 5-year FRNs at overnight SONIA + 35bps.