Replacing LIBOR: Is BTFR the Right Choice?

Date01 January 2018
Published date01 January 2018
DOIhttp://doi.org/10.1002/jcaf.22307
145
© 2018 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22307
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Replacing LIBOR: Is BTFR
the Right Choice?
Damir Tokic
INTRODUCTION
In June 2017, the
Alternative Refer-
ence Rate Committee
(ARRC), which is
the Federal Reserve
special task force,
recommended gradu-
ally replacing the
London Interbank
Offered Rate (LIBOR) with the
newly created Broad Treasury
Financing Rate (BTFR) as the
new benchmark for all variable
interest rate products. Similarly,
the Financial Conduct Author-
ity (FCA), which is the United
Kingdom–based LIBOR
regulatory agency, called for
replacement of all LIBOR
benchmarks by 2021. This is
very important, since there
is $350 trillion of derivatives
directly related to the LIBOR,
such as mortgages, credit cards,
student loans, and so on.
The LIBOR replacement
process is also important
for regulators. For example,
in August 2017, the FASB
Accounting Standards Update
(ASU) on Derivatives and
Hedging, Topic 815, added
the Securities Industry and
Financial Markets Associa-
tion (SIFMA) municipal swap
rate as the eligible benchmark
rate for a fair value hedge of
interest rate risk (Financial
Accounting Standards Board
[FASB], 2017). However, the
LIBOR swap rate and the
effective federal funds swap
rate, both permitted under
generally accepted account-
ing principles (GAAP), still
remained eligible as the inter-
est rate benchmarks. Thus, the
FASB will soon have to issue
another ASU to replace the
LIBOR with the new interest
rate benchmark.
This article questions
whether the LIBOR replace-
ment is justified and also
whether the BTFR benchmark
is the right choice for the
LIBOR replacement.
WHAT IS LIBOR?
Essentially,
LIBOR is a short-
term interbank interest
rate on eurodollars—
or U.S. dollars
outside the United
States. For example,
LIBOR is the refer-
ence interest rate
when banks outside the United
States borrow U.S. dollars from
another bank also outside the
United States.
Similarly, the effective fed-
eral funds rate is the reference
interest rate when banks inside
the United States borrow U.S.
dollars (overnight or very short
term) from another bank also
inside the United States. In this
case, the borrowing institution
is required to post the collat-
eral, usually the U.S. Treasury
securities or other acceptable
high-investment-grade securi-
ties. Thus, the effective federal
funds rate is a collateralized
risk-free interest rate.
However, the borrowing
institutions in the eurodol-
lar market are not required
to post the collateral and,
thus, the interbank lending in
The Alternative Reference Rate Committee (ARRC)
has recently recommended replacing the London
Interbank Offered Rate (LIBOR) with the newly
created Broad Treasury Financing Rate (BTFR).
This article discusses the drawbacks of LIBOR,
and whether BTFR is the right choice for the new
interest rate benchmark. © 2018 Wiley Periodicals, Inc.

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