ARRC will not be able to recommend a forward-looking SOFR term rate by mid-2021. New York has approved legislation to facilitate transition for tough legacy contracts.
Federal Reserve Vice Chair Randal Quarles on Monday (22 March) warned that banks must accelerate efforts to transition away from LIBOR, saying progress could have implications on their “safety and soundness risks”.
While most LIBOR rates will retire at the end of the year, key USD tenors have been extended for a further 18 months to end-June 2023. US regulators have repeatedly said these remaining tenors will not be available for the issuance of new contracts after December.
“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,” Quarles said during a keynote at The SOFR Symposium: The Final Year, hosted by the AARC (Alternative Reference Rates Committee) in New York.
“After 2021, we believe that continued use of LIBOR in new contracts would create safety and soundness risks, and we will examine bank practices accordingly.” The Fed has previously warned of supervisory action for financial institutions that are not ready to stop issuing LIBOR-based contracts by 31 December 2021.
Quarles noted that despite a regulatory push to get banks to stop their use of LIBOR, the use of the benchmark in outstanding contracts has actually risen – from USD 200 trillion in 2018 to USD 223 trillion in 2021.
“Given the sheer size of current exposures, we cannot afford to ignore the problems that an abrupt cessation of USD LIBOR would cause,” he said, adding that there is “no scenario in which a panel-based USD LIBOR will continue past June 2023.”
Tools available now
The USD 223 trillion figure cited by Quarles comes from a progress report released on Monday by the ARRC, which estimates that 60 percent of current LIBOR exposures will mature before mid-2023.
The ARRC report also highlights a “considerable uptick” in SOFR trading activity over 2020, pointing to advances in floating rate notes and consumer mortgage markets in particular.
However, the report raises concerns that lenders are not communicating enough with borrowers about LIBOR alternatives, banks are continuing to offer LIBOR as their primary or sole floating-rate business loan option, and the use of LIBOR in some products such as business loans and securitisations has not actually diminished.
The ARRC has also announced it will not be able to recommend a forward-looking SOFR term rate by mid-2021, due to a lack of trading activity in short-dated SOFR derivatives. It also cannot guarantee a robust forward-looking term rate will be produced by end-2021.
Accordingly, market participants are urged not to wait for a forward-looking term rate for new contracts, but to instead be prepared to use the tools available now, such as SOFR averages and index data that can be applied in advance or in arrears, as described in the User’s Guide to SOFR.
“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,” says Tom Wipf, ARRC Chairman and Vice Chairman of Institutional Securities at Morgan Stanley.
The ARRC estimates that an estimated USD 90 trillion in USD LIBOR exposures will remain outstanding after end-June 2023, and that this underscores the importance of finding solutions for legacy contracts.
According to Quarles, a legislative solution represents the best solution to address legacy LIBOR contracts governed by US law, and “no one should assume that there will be a synthetic USD LIBOR”.
In January, New York Governor Andrew Cuomo proposed legislation in the state budget that included provisions to help tough legacy LIBOR contracts switch to replacement rates recommended by the Federal Reserve Board, the New York Fed, or the ARRC.
On Wednesday (24 March), the New York state legislature approved the legislation, providing a statutory framework for outstanding LIBOR-linked contracts that contain no fallback provisions to be moved to a replacement rate.
The ARRC welcomed the passage of the legislation in a statement, saying it will be crucial in minimising legal uncertainty and adverse economic impacts associated with the LIBOR transition, and provide greater certainty to investors, businesses, and consumers.
“The ARRC applauds the passage of its proposed legislation, which marks a major milestone in the transition away from LIBOR,” Wipf said. “This legislation will address a key risk in the transition by providing a targeted solution for market participants who hold legacy contracts that have no effective fallbacks.”
Regulation Asia and Bloomberg are jointly hosting a webinar on 13 April to discuss measures to address key LIBOR transition challenges. Register here.