Markets Wired

As prepared for delivery

The Council first discussed the importance of reference rate reform in 2012, and a great deal of progress has been made since then.  The Alternative Reference Rates Committee, or ARRC, has worked to identify and address transition issues, including analysis of potential alternative rates and the recommendation to use the Secured Overnight Financing Rate, or SOFR.  SOFR provides a robust rate, suitable for use in most products and with underlying transaction volumes that are unmatched by other LIBOR alternatives.

The ARRC has also addressed other issues, including drafting clear and effective contractual fallbacks to alternative rates upon LIBOR’s cessation; facilitating the development of SOFR derivatives markets; developing conventions for the use of SOFR across asset classes; and proposing legislation, which New York State recently enacted, to help transition certain legacy contracts.

Despite this progress, we have reached a critical juncture, and more must be done to facilitate an orderly transition.  With U.S. dollar LIBOR’s cessation dates fully known, many market participants are actively evaluating their options and undertaking the work to transition contracts.  While important progress is being made in some segments of the market, other segments, including business loans, are well behind where they should be at this stage in the transition.

The decisions made now around the selection of alternative rates will determine whether some of LIBOR’s shortcomings may be replicated through the use of alternative rates that lack sufficient underlying transaction volumes.  I am concerned about recent use, and potential future growth in use, of these rates in derivatives, where the volume of derivatives contracts referencing these alternative rates could quickly outnumber the transaction volumes underlying the reference rate, leaving it vulnerable to manipulation and disruption – one of the primary issues with LIBOR.

Additionally, I understand the desire of some market participants for a forward-looking SOFR term rate, as it would provide a useful additional tool in the transition away from LIBOR.  I encourage market participants to act promptly to support the switch in derivatives from LIBOR to SOFR this summer, as suggested by the CFTC’s benchmark subcommittee on benchmark reform and the ARRC. It is important for term SOFR to be grounded in a deep SOFR derivatives market and to be used in a way that does not diminish that activity.  Action by market participants now will allow the ARRC to recommend a term SOFR rate quite soon.

The most critical step in the transition is the move toward truly robust alternative rates, like SOFR, which can mitigate the need for future transitions.  A failure to adopt robust alternative rates would leave us continuing to face the same risks and challenges that we face today.

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