Letter warns of use of LIBOR alternatives that may pose safety, soundness reputational risks

Adoption or use of some alternative interest rate references to replace the soon-to-be-defunct LIBOR may pose safety and soundness reputational risks, according to a letter sent Thursday to Federal Home Loan Banks (FHLBs) from their federal regulator.

In the letter from Federal Housing Finance Agency (FHFA) Deputy Director Andre D. Galeano, the FHLB presidents and chief financial officers were advised that, in recent months, “several organizations in the marketplace have announced or introduced other potential alternative reference rates that may be inconsistent with established principles for an acceptable reference rate.”

Galeano stated that FHLB use or adoption of the alterative rates (meant to replace the London Interbank Offered Rate, LIBOR, which will no longer be offered for use with new contracts, and which will be phased out completely for existing contracts by June 2023) “may significantly pose the same safety and soundness and reputational risks that befell LIBOR.”

He called the alternative rate developed by the Federal Reserve, the Secured Overnight Financing Rate (SOFR), “an appropriate and well-accepted replacement” for LIBOR. He noted the “alacrity” at which FHLB system has moved away from LIBOR to SOFR. But he issued a warning.

“To this end, DBR (the FHFA Division of Bank Regulation) does not believe the (FHLB) System should experience recidivism in adopting and using alternative reference rates that have shortcomings similar to those of LIBOR and other recently discontinued or soon to be discontinued reference rates,” he wrote.

FHFA Letter, Re: Alternative Reference Rate Selection Risk Management

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