Libor Replacement to Be Focus as Global Regulators Meet in D.C.

LAGOS (Capital Markets in Africa) – Libor isn’t gone yet, but global financial regulators want to make sure everyone understands that the scandal-tarred benchmark may be on its way out and that they are prepared to embrace an alternative rate.

The need for transition away from the London interbank office rate will be the focus of a discussion in Washington on Wednesday led by Randal Quarles, the Federal Reserve’s bank supervision chief and head of the Financial Stability Board. Market participants have been invited to share their views at the event, which will also include officials from the Bank of England, U.K. Financial Conduct Authority and Commodity Futures Trading Commission.

Libor, which is set daily based on bankers’ estimates, represents the interest rate firms are offering to one another in the interbank market for short-term loans. Regulators have been pushing lenders to ditch the benchmark that underpins $350 trillion of financial instruments following revelations that bankers had manipulated it for years. U.K. officials signaled its potential demise in 2017, saying they’ll stop compelling banks to submit quotes after 2021.

In response, regulators around the world have been tweaking existing reference rates to ensure they’re compliant with global rules, but none has the global breadth that Libor has had. The U.S. has opted to create an entirely new benchmark, the Secured Overnight Financing Rate, or SOFR, which is based on overnight repurchase agreement transactions secured by U.S. Treasuries.

“More engagement and participation in the development and adoption of new risk-free rates, like SOFR, is critical to executing a successful transition without igniting any global market disruptions,” said CFTC member Rostin Behnam, whose agency is hosting the meeting. “Time is of the essence.”

Under the guidance of the Fed’s Alternative Reference Rates Committee, a panel of regulators and representatives from the private sector, some futures and swaps trading is now tied to SOFR, and financial firms are issuing floating-rate debt tied to it. But volumes haven’t been robust enough to satisfy much of the market, so market participants have resisted transitioning to the new benchmark.

“There was a fog of uncertainty about what that change was going to look like, and so the reaction of many firms seemed to be to do nothing except wait and see what happens,” Federal Reserve Bank of New York General Counsel Michael Held said in a February speech. “We need decisive action by everyone in the market to avoid damage to individual firms and the financial system.”

The Bank for International Settlements said in March that a one-size-fits-all alternative to Libor may be not be feasible or even desirable. SOFR solves the rigging problem, but it doesn’t help market participants gauge how stressed global funding markets are, which means there’s likely to be more than one rate.

The ICE Benchmark Administration, which oversees Libor, is adjusting the methodology to make it more transaction-based. It’s also crafting an alternative, the Bank Yield Index. In the meantime, the volume of transactions that underpin Libor has slowed to a trickle at less than $1 billion a day.

Regardless, U.S. regulators continue to drive SOFR adoption. David Bowman, a senior adviser at the Fed, holds a weekly conference call to answer questions about the Libor transition. The Securities and Exchange Commission is urging companies to warn shareholders of potential impact of the transition on floating rate debt. And regulators continue to urge firms not to wait until Libor submissions cease because it could only trigger more volatility.

“There’s a cost and burden on market participants if they’re forced to exit,” Sayee Srinivasan, the CFTC’s deputy director of risk surveillance, said at a New York event in February. “The economist in me is hoping people will do the math and move on their own. I hope before 2021 they’ll have moved.”

Source: Bloomberg Business News