Thank you for the kind introduction, Ken, and for the opportunity to speak at today’s forum. I am pleased to join Edwin Schooling Latter of the U.K. Financial Conduct Authority (FCA) in offering some remarks, and will focus on the transition from U.S. dollar (USD) LIBOR. As always, the views I express today are my own, and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System.
We will soon cross into 2021, the most consequential year in the wind-down of USD LIBOR. Year-end is often a good moment to take stock of what we have accomplished and set goals for the year ahead. So today I’ll talk about the tremendous progress to date in the global effort to transition away from LIBOR, review recent accomplishments specific to USD LIBOR, and discuss top priorities—or “resolutions”—for the New Year.
It would be an understatement to say that 2020 has been an extraordinarily challenging year, with the COVID-19 pandemic leading to tremendous human hardship and significant disruptions to firms and financial markets. The pandemic also has further underscored LIBOR’s deficiencies, and strengthened the official sector’s resolve in the area of global interest rate benchmark reform. Progress in transition efforts this year has actually accelerated despite the challenging circumstances. In the past few weeks alone, there have been several major announcements signaling progress toward the end of LIBOR. It’s important to build on that momentum and continue the transition in a timely and orderly manner.
I’ll start today by looking back at important developments before turning to the year ahead. First, I’ll briefly review the global context of the LIBOR transition, including the Alternative Reference Rates Committee’s (ARRC) choice of the Secured Overnight Financing Rate (SOFR) as its preferred alternative to USD LIBOR. I’ll also discuss progress made on the transition during 2020. Then I’ll turn to the recent announcements on LIBOR’s future by its regulator, the FCA, and its administrator, ICE Benchmark Administration (IBA), along with guidance released by U.S. supervisors. Together, these provide a proposed path for LIBOR’s end.
As we take stock and then look ahead, I encourage you all to set New Year’s resolutions. And if you set only one for 2021 based on my remarks today, let it be this: No new LIBOR.
The Global Transition from LIBOR
The transition from LIBOR is a global challenge, given the widespread usage of the benchmark across five currencies: the U.S. dollar, euro, yen, pound sterling, and Swiss franc. The financial stability risks stemming from LIBOR have prompted reference rate reform efforts worldwide. The New York Fed is directly involved in this effort both domestically and globally—as a co-convener of the ARRC, as a producer of reference rates such as SOFR, and because President John Williams serves as co-chair of the Financial Stability Board’s (FSB) Official Sector Steering Group.
The FSB recently published a progress report on the global transition from LIBOR.1 The report highlights a common view across jurisdictions that the transition remains a significant priority. It also states that the “onus of action” is on firms, and notes that regulators will be monitoring progress closely.2
The importance of global reform efforts was reinforced by pandemic-related market disruptions. As discussed in the FSB progress report, activity in unsecured term wholesale bank funding markets—which had already experienced a structural decline following the global financial crisis—further dried up last March, forcing some LIBOR benchmarks to rely almost entirely on judgment-based submissions. In USD funding markets, volumes in some segments that LIBOR seeks to measure—such as three-month commercial paper issuance from banks—fell notably while exhibiting wide rate dispersion.3 This further highlighted the fundamental weaknesses of LIBOR.
The Transition to Alternative Reference Rates in the U.S.
Various national working groups were born out of global reference rate reform efforts to address the unique transition needs of individual countries and currencies. In the U.S., the Federal Reserve convened the ARRC.
The first challenge of the ARRC was to recommend an alternative to USD LIBOR. The ARRC developed key criteria to guide its selection of a “robust” benchmark.4 After an extensive evaluation process, the ARRC choose SOFR as its preferred alternative.5
As U.S. regulators have explained, market participants should seek to transition away from LIBOR in the manner that is most appropriate given their specific circumstances.6 The official sector supports continued innovation and further development of alternative reference rates.7
Among reference rates, SOFR is robust, is available now, and is already a well-established foundation for the transition from USD LIBOR. While the adoption of SOFR is voluntary, the rate’s characteristics clearly demonstrate why the ARRC selected it as its recommended alternative to USD LIBOR. SOFR is fully transaction-based, produced by the New York Fed in accordance with IOSCO’s Principles for Financial Benchmarks, and draws from a deep underlying market (the U.S. Treasury overnight repurchase agreement market) with substantial transaction volumes and broad participation.8
Milestones for Supporting SOFR Use and Liquidity
The ARRC has developed a detailed supporting framework for using SOFR, including tools such as fallbacks and recommended conventions for new use of SOFR in various products.9
In this past year alone, there have been numerous consultations, tools, and recommendations from the ARRC and others that should bolster use of SOFR and keep the industry on track for a smooth transition from USD LIBOR. To highlight a few:
- The New York Fed began publishing 30-day, 90-day, and 180-day compounded averages of SOFR and a SOFR Index that can be used to calculate compounded average rates over custom time periods, allowing for the use of SOFR as a term rate in any contract.10
- The ARRC issued Recommended Best Practices, including recommended dates for completing the transition across floating-rate notes, business loans, consumer loans, securitizations, and derivatives. 11
- CME and LCH switched their discounting and calculation of price alignment interest (PAI) for interest-rate derivatives from referencing the Effective Federal Funds Rate (EFFR) to SOFR.
- The International Swaps and Derivatives Association (ISDA) launched its IBOR Fallback Protocol and IBOR Fallback Supplement to implement new fallbacks for legacy and new derivative contracts.12 In the case of USD LIBOR, the fallback rate will be SOFR compounded in arrears, with a spread adjustment.
- The ARRC established an RFP process for forward-looking term SOFR rates, to be published in 2021 if liquidity in SOFR derivatives markets has developed sufficiently.13 The ARRC also issued an RFP for the administration of its recommended LIBOR fallback spread adjustments and spread-adjusted rates for cash products that transition away from USD LIBOR.14
The End of LIBOR, Coming into Focus
The architecture for transitioning from LIBOR to SOFR has strengthened in the U.S. and around the globe, and we recently received more clarity on the proposed end of LIBOR.
Following a pair of announcements in November,15 IBA released a consultation last week on its intention to cease publication of all non-USD LIBORs and one-week and two-month USD LIBORs after December 31, 2021, while ceasing publication of the remaining USD LIBOR settings (overnight and the one-, three-, six-, and 12-month tenors) after June 30, 2023.16 IBA anticipates there being a representative panel for the continuation of these USD LIBOR settings through to June 30, 2023.
When the feedback period concludes in late January, IBA has indicated that it will share the results with the FCA and summarize the results publicly shortly thereafter.
There have also been key announcements from supervisors related to USD LIBOR:
- First, the FCA welcomed IBA’s consultation to cease USD LIBOR and said that it will coordinate with relevant authorities to consider whether and, if so, how to most appropriately limit new use of USD LIBOR by supervised entities in the UK.17
- In addition, U.S. supervisors—the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation—issued strong and clear supervisory guidance, stating: “Given consumer protection, litigation, and reputation risks, the agencies believe entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly. Therefore, the agencies encourage banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021. New contracts entered into before December 31, 2021 should either utilize a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation. These actions are necessary to facilitate an orderly—and safe and sound—LIBOR transition.” 18
These announcements from various stakeholders should be understood as a collective framework that lays out a proposed path to a smooth transition away from USD LIBOR. That framework includes:
- No new use of LIBOR as soon as is practicable, and no later than end-2021, and
- A proposal, subject to consultation outcomes, that would allow most USD LIBOR-linked legacy contracts to mature before USD LIBOR ends.
All told, these actions propose a final wind-down and end date for USD LIBOR as a representative, panel-based rate. There will be no guesswork; pending the results of the consultation, the end game would be certain. 19 By end of 2021, new use of LIBOR should stop. And by mid-2023, firms should have cleaned up any remaining legacy contracts. The message is clear: transition efforts cannot be put off.
Top Priorities for 2021
With that end game in mind, I will suggest three New Year’s resolutions for the transition away from LIBOR:
The first and most important: No new LIBOR.
All firms should stop writing new LIBOR contracts as soon as practicable and in any event no later than end-2021. Firms will have to take progressive steps well before then to ensure readiness and build capacity for entering into contracts that use robust alternatives to LIBOR, such as SOFR. The ARRC has laid out best practice dates to accomplish this ahead of the end of 2021.
Accelerating this work is critical for a number of reasons. As U.S. regulators have made clear, supervised firms should stop using LIBOR in new contracts as soon as practicable in the New Year. Firms will need to be prepared both internally and externally to transition their products and services to robust alternatives. When the New Year’s ball drops on LIBOR next year, every bank should be striving for a clean bill of health from their supervisor.
Moving quickly will also avoid making the problem worse. With an estimated $200 trillion in gross exposure to USD LIBOR, there is already an enormous number of contracts that will need to transition from LIBOR, and it is detrimental to add on to that.20 As ARRC Chair Tom Wipf often says, the first step for getting yourself out of a ditch is to stop digging!
The second resolution, which extends from the first: Build SOFR into your diet.
With the end of LIBOR in sight, firms should be accelerating plans to transact in SOFR-based cash and derivatives products if they aren’t prepared already. While the use of SOFR as an alternative to LIBOR is voluntary, SOFR-based instruments are already replacing LIBOR in most markets. In derivatives markets, the transition is well underway, and liquidity is growing. Developments such as the CCP discounting change to SOFR are supporting growth of SOFR derivatives. In cash markets, recent floating-rate note issuance has used SOFR more than LIBOR.21 And SOFR will be the basis for future agency adjustable-rate mortgage products.22
As I mentioned earlier, the ARRC has a wide range of resources to help market participants get familiar with and begin adopting SOFR, including conventions for various cash instruments—most recently, conventions for syndicated and bilateral business loans. If firms increasingly use SOFR when writing new cash contracts, that will build demand for SOFR derivatives. In turn, this should enable more SOFR-linked issuance in cash markets—a virtuous cycle. Liquid SOFR derivatives markets are also a necessary criterion for developing forward-looking term SOFR rates, the last step in the ARRC’s Paced Transition Plan.23
The third and final resolution: Work off those legacy LIBOR exposures.
Last week’s announcements complement existing tools and proposed legislative solutions to support an orderly wind-down. The proposed mid-2023 end date for publishing USD LIBOR’s major tenors will allow the bulk of legacy USD LIBOR exposures to mature. That should significantly narrow the remaining work that needs to be done. Firms should identify contracts that extend past mid-2023 and remediate them. As I mentioned earlier, there are tools in place to incorporate effective fallback language for derivatives and many cash instruments. And for the toughest legacy contracts—those that have no effective means of transition away from LIBOR upon its cessation—there is an important solution in the works. Here, the ARRC has proposed legislation24 that would allow such contracts—largely securitizations and floating-rate notes—to smoothly transition to SOFR.25 The ARRC recently discussed principles that articulate support for an effective legislative solution.26 Further, the ARRC sees the type of legislation it has urged New York State to adopt as the best model for achieving this, whether enacted at the state or federal level, and it encourages all market participants to support the proposal.
Conclusion
The transition from LIBOR is a substantial and complex undertaking. While significant work remains, I am heartened by the progress to date, particularly amid such challenging circumstances. Recent announcements have made the proposed end of LIBOR clear, and firms should stop new use of LIBOR by end-2021. We have already taken many steps to build a strong supporting framework for the transition. As we head into 2021, I encourage each of you to adopt these LIBOR resolutions for your firms, so that when we meet at this time next year, your transition is already done.
Happy holidays, and best wishes for no new LIBOR in the New Year!
