The Federal Reserve Bank of New York’s vice president called upon the financial sector to focus squarely on the 2021 deadline as the endgame for Libor transition.
“I would suggest that 2023 isn’t the date you need to be focused on right now,” NY Fed’s executive vice president Michael Held said at an International Swaps and Derivatives Association (ISDA) event on Wednesday.
“At the end of this year, every firm needs to have stopped using Libor for all new exposures.”
“That’s not only a recommendation or best practice or just a good idea. It is explicit supervisory guidance.”
Even though USD Libor rates will continue to be published until June 2023, there are now only 100 days left to cease all new Libor issuance. The USD market’s Libor transition has indeed accelerated as policymakers have progressively incentivised the sector to move towards Sofr – recently extending formal endorsement to its term-rate version.
Earlier in July, the Commodities and Futures Trading Commission (CFTC)’s Sofr first initiative saw interdealer markets shift to Sofr as their default reference rate for USD linear derivatives.
Overall, there has been a sizeable increase in Sofr trading activity since Sofr First’s official start. In June (the last full month before the start date), only 6 percent of over-the-counter (OTC) and exchange-traded derivatives, as measured in DV01, referenced Sofr. For the month of August, Sofr-referenced contracts had increased to 12 percent.
“It’s now clear that there has been a sustainable pickup in Sofr swap trading activity in the market,” Rostin Behnam, acting chairman of the CFTC, said at the ISDA event.
“This increase is directly attributable to Sofr First and shows that phase one of the initiative was a success.”
Phase two, “RFR (Risk-Free-Rates) First” will go into effect next week on September 21 and will see trading conventions for USD cross-currency swaps with Sterling, Yen and Swiss Franc also switch to Sofr.
Benham said that additional trade convention switches are planned by the end of the year.
“The remaining phases of Sofr First involving exchange-traded derivatives and nonlinear derivatives, which includes swaptions caps and floors, will occur in the fourth quarter of this year.”
Pressure mounts on slow-moving lending market, credit-sensitive rate users
Within the lending market, Held warned that banks need to be more proactive in moving away from Libor.
“Lending banks especially need to move to alternatives and push their borrowers to move as well.”
Held referenced an Alternative Reference Rates Committee (ARRC) survey published in March highlighting that nearly two-thirds of non-financial corporates said banks were not offering non-Libor lending alternatives at the time.
“That’s a problem,” said Held. “Not just for the bank that don’t seem to be moving off Libor, but also for the borrowers who will need time to rework their internal systems and processes before using a new rate.”
He also renewed concerns on alternate rates – specifically credit-sensitive rates – that the lending market has shown interest in, reiterating that Sofr would be the most robust rate and firms that use non-risk-free rates would be under scrutiny.
“If your firm is moving to a rate other than Sofr, that means you have extra work to make sure you’re demonstrably making a responsible decision.”
“It’s especially important for firms that are using credit-sensitive rates to really do their due diligence to have a full understanding of the rates they choose, including any fragilities in the rate or the markets that underlie it, and to make sure their contracts have solid fallbacks to protect against those fragilities.”
Though regulators are not prohibiting the use of alternate rates, they have been actively discouraging their use.
Last week, the International Organization of Securities Commissions (IOSCO) added to pressure on credit-sensitive rates, warning they could replicate the shortcoming of Libor.
“Users of [credit-sensitive rates] should also consider the robustness and reliability of the benchmarks they choose and ensure that they have reliable fallback mechanisms that can be used, should their chosen benchmarks cease or become unrepresentative.”
Overall, however, the formal recommendation of a term Sofr rate by the ARRC has helped pre-empting the utility of credit-sensitive rates. Borrowers themselves also prefer risk-free rates as the cost of borrowing is less likely to fluctuate during times of market stress.