Intercontinental Exchange London Interbank Offered Rate (ICE LIBOR)

What Is the Intercontinental Exchange London Interbank Offered Rate (ICE LIBOR)?

The Intercontinental Exchange London Interbank Offered Rate (ICE LIBOR) is the average of the interest rates that some of the world’s leading banks charge each other for short-term loans. As for Intercontinental Exchange (ICE), it’s the parent company of the New York Stock Exchange (NYSE) and a couple of dozen other exchanges and markets around the world. ICE took over the administration of LIBOR from the British Bankers Association in early 2014. However, the entire LIBOR system is scheduled to be phased out by 2023 and replaced with other benchmarks, such as the Sterling Overnight Index Average (SONIA).

How the Intercontinental Exchange London Interbank Offered Rate (ICE LIBOR) Works

LIBOR (in common parlance, the “ICE” is often dropped) serves as the first step to calculating interest rates on various loans throughout the world. There are actually several LIBORs—every morning ICE issues benchmark rates for loans in five currencies, for seven maturities. The currencies are the U.S. dollar, pound sterling, euro, Japanese yen, and Swiss franc, while the maturities are overnight, one week, and one, two, three, six, and 12 months. While that makes for 35 different LIBORs, the one most commonly quoted is the three-month dollar rate. If you hear someone referring to “today’s LIBOR” without further qualification, it’s safe to assume that it’s the three-month dollar rate they’re referring to.?

LIBOR’s practical applications are universal. The rate is included by name in the standard language of many loan documents, and its influence ranges from the advanced realm of swaps and derivatives to more commonplace concerns such as student loans and mortgages. Once you’re approved, you pay a going rate, plus a few basis points of LIBOR. A decrease in LIBOR should result in a few dollars saved on any subsequent home loan, whether that loan is either directly or implicitly tied to LIBOR.

LIBOR Calculation

For purposes of calculating LIBOR, ICE submits a questionnaire to its member banks that includes the following open-ended query, subject to the respondent’s whims:

At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 a.m. London time?

Thus, the composition of ICE LIBOR is conditional on the objectivity of whichever bank employees are entrusted with answering the question. ICE even acknowledges that it deliberately keeps the phrase “reasonable market size” undefined and ambiguous.

Depending on the currency involved, anywhere between 11 and 18 of the member banks answer ICE’s question. ICE then ranks the banks’ rate estimates, discards the top and bottom quartiles, and takes the average of the remaining 5 to 10 rates.

Special Considerations

One reason why Intercontinental Exchange stresses the use of the full term “ICE LIBOR” is that its calculation today differs from that during its previous existence under the purview of the British Bankers Association. Back then, LIBOR was released for an additional five currencies, and for an additional eight maturities.

Furthermore, BBA calculated the rate by examining and averaging the rates charged by its 200-odd member banks worldwide. This made for a fair consensus rate or should have if one influential member bank’s group chair (who, purely coincidentally, was the BBA’s chair emeritus) hadn’t authorized made-up numbers for LIBOR’s daily calculations. In fact, there were several BBA member banks that conjured rates out of the ether. After the scandal went public in 2012, LIBOR needed a new home.

Since ICE took over LIBOR, the number of contributing banks is fewer than 20. This would seem to be counterintuitive and offer the potential for wide variance, yet the remaining banks now have greater incentive to be honest as they report to a governing body that is less tolerant.

ICE LIBOR vs. Other Benchmarks

How does LIBOR differ from other major benchmarks, such as the federal funds rate? Well, the latter is announced about eight times a year instead of daily. Also, the federal funds rate is an instrument of a nation’s monetary policy. When the Fed decides that the time is opportune to augment or diminish the money supply, or its growth rate, lowering or raising the federal funds rate is one way to accomplish that. Meanwhile, LIBOR is obviously international in scope and is supposed to be more a metric of what interest rates are, rather than what one country’s central bank believes they ought to be.