September 28, 2020 | Vanguard Perspective
An important benchmark in the financial industry, the London Interbank Offered Rate, or LIBOR, will cease to exist after 2021. It is used as an input in setting the interest rates on a variety of financial products worldwide, including bonds, derivatives and loans to businesses and consumers.
Bloomberg has estimated the exposure of all financial instruments using LIBOR as a benchmark reference rate at $200 trillion in the United States and $350 trillion globally.1
The U.K.'s Financial Conduct Authority, the oversight body regulating LIBOR since 2013, has reached an agreement ensuring a panel of banks will continue submitting daily estimated borrowing rates through December 2021, but will not require their submissions after that.
A variety of different reference rates is being considered across the globe to replace LIBOR, but its successor in the United States is the Secured Overnight Financing Rate, or SOFR. This interest rate, published daily by the Federal Reserve Bank of New York, is based on transactions in Treasury repurchase agreements—overnight financing for banks that sell U.S. Treasuries and agree to repurchase them the next day for a set interest rate.
Replacing LIBOR as a reference rate in instruments expiring after 2021 could carry tax implications. Substantive changes to debt instruments, including replacing a reference rate, can be deemed by the IRS to be a taxable exchange, requiring the holder of the debt instrument to recognize a gain or loss.
The U.S. Internal Revenue Service (IRS) has proposed regulations that would allow issuers to replace LIBOR with SOFR (as well as certain other "qualified" rates), without causing a taxable exchange, so long as the replacement does not significantly change the fair market value of the debt instrument.
Once finalized, these IRS regulations are likely to provide a way for issuers to replace LIBOR in a manner that would cause holders to avoid recognizing a gain or loss for U.S. federal income tax purposes.
Because some Vanguard funds have exposure to LIBOR, we have established a governance program and developed a plan to help us navigate a transition away from that benchmark. This includes planning for our investment products' LIBOR transition, remediating systems that display or use LIBOR in calculations, revising online and print materials, and exploring solutions to remediate existing legacy contracts to incorporate provisions for LIBOR transition and fallback language.
We will continue to work toward the transition away from LIBOR while monitoring market developments and taking steps to ensure that it goes as smoothly as possible. Our focus while doing so will be, as always, to give our investors the best chance for investment success.
1 Data are as of August 2019.