Movement away from LIBOR needs to ‘materially escalate,’ group advises; some new loans still using reference rate

Progress away from use of a popular interest rate reference tool will need to “materially accelerate” for the market to be adequately prepared to use a new reference tool, according to a report issued Monday by a Federal Reserve Bank committee.

The report notes, in particular, that some products, such as business loans, have not diminished the use of the London Interbank Offer Rate (LIBOR) in setting interest rates. “With essentially nine months left to end-2021, it is critical that market participants are actively taking steps to support the transition using the tools available now,” said Tom Wipf, chairman of the Fed Bank of New York’s Alternative Reference Rates Committee (ARRC,) in a release.

The ARRC report notes that use of one alternative rate – the Secured Overnight Financing Rate (SOFR), which the group selected four years ago as its preferred alternative reference rate – has seen a “considerable uptick” in trading activity through 2020 in floating rates notes and consumer mortgage markets in particular.

However, the group said its report “spotlights areas where progress has been close.” The group said the report includes updated data on outstanding exposures to U.S. dollar (USD) LIBOR and shows that use of LIBOR has continued in some markets. “Although an estimated 60% of current LIBOR exposures will mature before June 2023, an estimated $90 trillion will remain outstanding – a fact that underscores the importance of finding solutions for legacy contracts,” ARRC said in its release.

LIBOR is widely used by financial institutions as a reference rate for adjustable-rate mortgages and other loan contracts. The rate is being phased out because the transactions it is based on don’t occur as often as they did in prior years.

In November, the federal banking agencies advised institutions they supervised that the rate should not be used for new contracts and, in any event, not following Dec. 31, 2021, after which regulators have said they can no longer guarantee production of the rate.

“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,” the agencies wrote last fall. “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.”

The agencies said then that new contracts entered into before Dec. 31, 2021, should either use a reference rate other than LIBOR or have “robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.”

According to Federal Reserve Board Vice Chair for Supervision Randal Quarles, the administrator of LIBOR – the ICE Benchmark Administration (IBA) – has announced that it will no longer have the necessary panel bank submissions to continue to publish any nondollar LIBOR tenors or one-week or two-month U.S. dollar (USD) LIBOR after Dec. 31.

Additionally, Quarles said in a speech Monday, IBA will no longer have the necessary panel bank submissions to continue publishing overnight, one-month, three-month, six-month, or one-year USD LIBOR after June 30, 2023.

Progress Report: The Transition from U.S. Dollar (USD) LIBOR