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This piece highlights multiple intricacies involved in replacing the London Inter-bank Offered Rate (LIBOR), which is expected to cease by the end of 2021. The first critical issue arising is the legacy contract referencing Libor rate ($53 trillion of existing contracts post-2021). The second is finding a suitable global benchmark that has the ability and credentials to take its place. One possibility is Secured Overnight Reference Rate (SOFR) , however, currently SOFT only represent a small fraction of Libor linked instrument ($100 billion vs $400 Trillion). Moreover, switching to an alternative reference rate would be costly from the credit, risk, compliance, and technology adoption points of view – with asymmetric incentive involved in paying these costs.
Why does this matter? This article does a good job in highlighting how replacing LIBOR can pose a systematic risk for the global economy. Whilst the world is busy predicting recession and the outcome of the Trade War, an unprecedented global financial engineering and transition away from LIBOR has the ability to shock the market by the end of 2021.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)