Quarles: ‘No scenario’ under which LIBOR will continue past its phase-out period

“There is no scenario” in which a popular interest rate reference tool, scheduled to be phased out beginning at the start of next year, will continue past June 2023, “and nobody should expect it to,” the Federal Reserve’s top supervisor said Monday.

In remarks to a symposium on reference rates sponsored by the Federal Reserve Bank of New York’s (and not Boston’s, as previously reported) Alternative Reference Rates Committee (ARRC), Federal Reserve Board Vice Chair for Supervision Randal Quarles said recent statements about the discontinuation of the London Interbank Offer Rate (LIBOR) are definitive.

The statements, issued by the administrator of LIBOR (the ICE Benchmark Administration [IBA]) said that the group 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, 2021. The group also said it 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.

Quarles noted that late last year, the Fed and the other federal banking agencies issued guidance about use of LIBOR after 2021: “that continued use of LIBOR in new contracts would create safety and soundness risks, and we will examine bank practices accordingly.”

The Fed’s top supervisor said the announcements from the agencies (and from the ARRC) are “absolutely not” meant to support new LIBOR activity or continued business as usual. “Instead, they are meant to completely end the new use of LIBOR while allowing a significant portion of legacy contracts to roll off before the key dollar LIBOR tenors stop publication,” he said.

Quarles said even with the regulators’ guidance on new LIBOR contracts, of the $223 trillion in contracts now using LIBOR, 40% of those (about $90 trillion) will not mature before mid-year 2023. “Some of these contracts should already have workable fallback language, but many still have no effective means to replace LIBOR upon its cessation,” he said.

He asserted that the Federal Reserve believes that legislation is the way to go to address those contracts. “The ARRC has proposed legislation with the state of New York, which may be appropriate given that many of the contracts that the ARRC’s proposal seeks to address are governed by New York law,” he said. “Members of Congress are also considering federal legislative solutions, and we support these efforts as well.”

Quarles also pointed to instructions to Fed examiners (contained in supervisory letter SR 21-7) that underscore the agency’s concern about banks stopping use of LIBOR in new contracts “as soon as practicable” and, in any event, by Dec. 31.

“SR 21-7 outlines factors that examiners should consider in assessing transition efforts and states that, if supervised firms are not making adequate progress in transitioning away from LIBOR, examiners should consider issuing supervisory findings or taking other supervisory actions,” Quarles said. “Recognizing that smaller banks generally are less reliant on LIBOR, we have tailored our supervisory approach for community banks and firms under $100 billion in assets.”

Quarles also issued a somewhat veiled threat to the banking industry, which he said has ramped up use of LIBOR in spite of the knowledge the reference rate was being phased out and guidance from the banking agencies. “Market participants have had many years to prepare for the end of LIBOR, yet over the last few years they have actually increased use of LIBOR,” Quarles said. “Given the announcements of the FCA (Financial Conduct Authority, the United Kingdom’s top financial regulator) and the IBA, that must obviously change this year – that’s just the laws of physics – and the firms we supervise should be aware of the intense supervisory focus we are placing on their transition, and especially on their plans to end issuance of new contracts by year-end.”

Federal Reserve Vice Chair for Supervision Randal K. Quarles Keynote Remarks, “The SOFR Symposium: The Final Year”