The “year of magical thinking” is over, and market participants should act now to accelerate their transition away from LIBOR, the Federal Reserve’s top supervision officer said Tuesday.
Federal Reserve Board Vice Chair for Supervision Randal Quarles, speaking before the Structured Finance Association Conference in Las Vegas, said the “reign” of the London Interbank Offered Rate (LIBOR) will end at year’s end “and it will not come back.”
“One-week and two-month USD LIBOR will end in only 12 weeks,” Quarles said. “The remaining USD (U.S. dollar) LIBOR tenors will end in mid-2023, but the LIBOR quotes available from January 2022 until June 2023 will only be appropriate for legacy contracts.
“Use of these quotes for new contracts would create safety and soundness risks for counterparties and the financial system. We will supervise firms accordingly,” he said.
The Fed supervision leader said it has been clear for several years that LIBOR (a benchmark used to set interest rates for, among other things, commercial and student loans, mortgages, securities, derivatives) would end. “But some believed it was not clear exactly when LIBOR would end,” Quarles said. “And, as a result, many market participants have continued to use LIBOR as if that end date would surely be in some indefinitely distant future, as if LIBOR would remain available forever.”
But now, Quarles indicated, there is clarity: The United Kingdom’s Financial Conduct Authority (FCA), which regulates LIBOR, and ICE (Intercontinental Exchange) Benchmark Administration (IBA), which administers LIBOR, announced definitive end dates for LIBOR. No U.S. dollar LIBOR tenors will not be available after June 30, 2023, he reminded the group. (No new contracts will be written using LIBOR after year’s end.)
That said, he added, a handful of financial firms have said that they may want more time to evaluate potential alternative rates. “There is no more time, and banks will not find LIBOR available to use after year-end no matter how unhappy they may be with their options to replace it,” he said.
He said it is critical, now, for capital and derivatives markets to transition to the Secured Overnight Finance Rate (SOFR), a LIBOR alternative developed by an industry group hosted by the Federal Reserve (the Alternative Reference Rate Committee, ARRC). Quarles noted that use of SOFR has been in public development for more than four years. “Market participants have expressed nearly universal agreement that this is the right replacement rate for such products,” Quarles said. “The ARRC did not recommend any other rate for capital markets or derivatives, and market participants should not expect such rates to be widely available.”
Loans, however, are a different animal, Quarles indicated – citing as evidence that none of the federal banking agencies (nor the federal credit union regulator) have endorsed a specific LIBOR replacement rate. “We have not changed that guidance,” Quarles said. “A bank may use SOFR for its loans, but it may also use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs.”
In any event, Quarles said, LIBOR is coming to an end as of Dec. 31. “But a bank will not find LIBOR available after year-end, even if it doesn’t want to use SOFR for loans and hasn’t chosen a different alternative reference rate,” he said.
He added that reviewing banks’ cessation of LIBOR use after year-end will be “one of the highest priorities of the Fed’s bank supervisors in the coming months.”
He said if market participants do use a rate other than SOFR, “they should ensure that they understand how their chosen reference rate is constructed, that they are aware of any fragilities associated with that rate, and – most importantly – that they use strong fallback provisions.”