Randal K. Quarles, Vice Chair for Supervision of FED, shared his remarks at the Alternative Reference Rates Committee (ARRC) Roundtable. He talked about the next critical stage in the transition away from LIBOR. He highlighted that regardless of how one chooses to transition, beginning that transition now would be consistent with prudent risk management and the duty owed to the shareholders and clients.
Mr. Quarles mentioned that FED convened the ARRC based on the concerns about stability of LIBOR. The ARRC was charged with providing the market with tools that would be needed for a transition from LIBOR—an alternative rate that did not share the same structural instabilities that have led LIBOR to this point, a plan to develop liquidity in the derivatives market for this new rate so that cash users could hedge their interest rate risk, and models of better contract language that helped limit the risk from a LIBOR disruption. The ARRC has provided these tools and, with only two and a half years of further guaranteed stability for LIBOR, the transition should begin happening in earnest. He mentioned that the work of ARRC began by focusing on creating a derivatives market for the Secured Overnight Financing Rate (SOFR). As liquidity in these markets continues to develop, he hoped that many will close out their LIBOR positions.
He also mentioned that, to ensure global financial stability, it is important that everyone participate in the ISDA consultations on better fallback language for LIBOR derivatives and then sign the ISDA protocol so that these fallbacks apply to the legacy book of derivatives. Similarly, ARRC's fallback recommendations represent a significant body of work on the part of a wide set of market participants and set out a robust and well-considered set of steps that expressly consider an end to LIBOR. There is, however, also another and easier path, which is simply to stop using LIBOR. As good as the fallback language may be, simply relying on fallback language to transition brings a number of operational risks and economic risks. Firms should be incorporating these factors into their projected cost of continuing to use LIBOR and investors and borrowers should consider them when they are offered LIBOR instruments.
At a recent roundtable on the LIBOR transition held by FSB, private sector requested to provide greater clarity on regulatory and tax implications of the transition. Mr. Quarles highlighted that the official sector is taking these requests seriously. For example, FED is working with CFTC and other U.S. prudential regulators to provide greater clarity on the treatment of margin requirements for legacy derivatives instruments. Agency staff are developing proposed changes to the margin rules for non-cleared swaps to ensure that changes to legacy swaps to incorporate a move away from LIBOR, including adherence to the ISDA protocol, would not affect the grandfathered status of those legacy swaps under the margin rules.
The supervisory teams of FED have already included a number of detailed questions about plans for the transition away from LIBOR in their monitoring discussions with large firms. The supervisory approach will continue to be tailored to the size of institution and the complexity of LIBOR exposure, but the largest firms should be prepared to see supervisory expectations for them increase. Finally, he mentioned that some have recently claimed that the supervisory stress tests of FED would penalize a bank that replaces LIBOR with SOFR in loan contracts by lowering projections of net interest income under stress. In the recently published enhanced descriptions of the supervisory stress-test models, the supervisory projections of net interest income are primarily based on models that implicitly assume that other rates such as LIBOR or SOFR move passively with short-term Treasury rates. Given these mechanics, choosing to lend at SOFR, rather than LIBOR, will not result in lower projections of net interest income under stress in the stress-test calculations of FED.
Related Link: Speech
Keywords: Americas, US, Banking, Securities, LIBOR, SOFR, ARRC, Interest Rate Risk, Fallback Language, Margin Requirements, Stress Testing, Risk-Free Rates, ISDA, FED
Previous ArticleBundesbank Updates Derivation Rules for Completeness Check Under SSM
The European Commission (EC) published a report summarizing responses to the targeted consultation on the supervisory convergence and the single rulebook in the European Union (EU).
The Office of the Superintendent of Financial Institutions (OSFI) published an update on the discussion paper that intended to engage federally regulated financial institutions and other interested stakeholders in a dialog with OSFI, to proactively enhance and align assurance expectations over key regulatory returns.
The European Central Bank (ECB) published its opinion on a proposal for a regulation on European green bonds, following a request from the European Parliament.
The Advisory Scientific Committee (ASC) of the European Systemic Risk Board (ESRB) published a report that explores the expected impact of digitalization on provision of financial and banking services, and proposes policy measures to address the risks stemming from digitalization.
The European Banking Authority (EBA) announced that the guidelines on the reporting and disclosure of exposures subject to measures COVID-relief measures shall continue to apply until further notice.
The Swedish Financial Supervisory Authority (FI) announced that the capital adequacy reporting as at December 31, 2021 must be done by February 11, 2022.
The Central Bank of the Philippines (BSP) issued communications covering developments related to online lending platforms, open finance framework and roadmap, and on the expected regulations in the area sustainable finance.
The Board of Governors of the Federal Reserve System (FED) published the final rule that amends Regulation I to reduce the quarterly reporting burden for member banks by automating the application process for adjusting their subscriptions to the Federal Reserve Bank capital stock, except in the context of mergers.
The European Banking Authority (EBA) published its assessment of risks through the quarterly Risk Dashboard and the results of the Autumn edition of the Risk Assessment Questionnaire (RAQ).
The Malta Financial Services Authority (MFSA) updated the guidelines on supervisory reporting requirements under the reporting framework 3.0.