Board of Governors of the Federal Reserve System ("FRB") Governor Jerome H. Powell described some of the considerations around a transition from the London Interbank Offered Rate ("LIBOR") to an alternative rate.
In remarks at the Roundtable of the Alternative Reference Rates Committee ("ARRC") held at the Federal Reserve Bank of New York, Governor Powell described how LIBOR came under scrutiny during the financial crisis due to reports of manipulation by bank employees. Mr. Powell said the FRB concluded that the largest problem faced by LIBOR was the dearth of underlying transactions serving as the basis for the rate. This left LIBOR susceptible to manipulation, he said. In addition, Governor Powell asserted that a transactions-based rate determined by activity in wholesale unsecured funding markets was not feasible.
Governor Powell acknowledged a recent speech by Andrew Bailey of the UK's Financial Conduct Authority explaining efforts to keep banks on the LIBOR panels. Mr. Powell noted that this has become "increasingly difficult." As a result, he warned market participants they should not assume that LIBOR will be sustained past 2021.
Governor Powell commended the ARRC selection of an alternative rate based on overnight Treasury repurchase agreements (the " Secured Overnight Financing Rate"). He explained that the transition process to an alternative rate will be extremely complicated, especially for legacy transactions. He also publicly recognized the efforts of the FSB and ISDA to develop documentation solutions for the derivatives markets, and advised market participants to review their documentation for other types of contracts.
Commentary / Lary Stromfeld
The importance of ARRC's work cannot be overstated. Over $100 trillion of contracts use LIBOR, which today remains in effect largely through life support encouraged by the regulators in spite of enhanced governance standards. ARRC has identified a robust, transaction-based rate ("SOFR") as a potential alternative. However, the challenges for this new overnight unsecured rate to replace LIBOR are already obvious. Many will be addressed through the continued hard work and coordination of regulators and market participants. But the greatest challenge will be addressing legacy transactions that do not have fallback provisions that work in the new environment. This is especially difficult for the cash markets. Regulators should consider how they could use their authority and influence to help bridge this gap.
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