The International Organization of Securities Commissions (IOSCO) published a statement reiterating the importance of continued transition to robust alternative financial benchmarks—that is, risk-free rates—to mitigate potential risks arising from the cessation of LIBOR, including the USD LIBOR. The IOSCO also notes that the alternative financial benchmarks will need to be compliant with the IOSCO Principles on Financial Benchmarks. It also notes that credit-sensitive rates that are interest rate benchmarks that measure the credit risk component of unsecured borrowing in certain markets have started to emerge as a possible alternative to the USD LIBOR. IOSCO highlights that alternative financial benchmarks need to be compliant with the IOSCO Principles on Financial Benchmarks. With respect to the credit-sensitive rates, IOSCO calls for greater attention to Principles 6 and 7.
Principle 6 asks administrators to consider the “relative size of the underlying market in relation to the volume of trading.” Principle 7 emphasizes “data sufficiency in a benchmark’s design to accurately and reliably represent the underlying market” measured by the benchmark. Therefore, in line with the Principles 6 and 7, IOSCO calls on administrators to assess whether the systemic benchmarks that are used extensively are based on active markets with high volumes of transactions, representing the underlying interest they intend to measure and whether such benchmarks are resilient during times of stress. Regulators are concerned that some shortcomings of LIBOR may be replicated through the use of credit-sensitive rates that lack sufficient underlying transaction volumes.
In its statement, IOSDCO notes that the disproportionality between the low/modest volume of transactions underlying credit-sensitive rates and the increasingly higher volumes of activity in markets referencing them (inverted pyramid problem) raises concerns about market integrity, conduct risks, and financial stability risks. The decline in the underlying activity of some of the credit-sensitive rates during stress periods, such as the COVID-19 pandemic, raises additional regulatory concerns. Therefore, benchmark administrators of credit-sensitive rates should consider how their benchmarks would continue to meet Principles 6 and 7 over time, in case use of a benchmark becomes widespread. Some of these rates are based on markets similar to LIBOR and may replicate many shortcomings of LIBOR, as highlighted by the authorities in the US and the UK. Users of benchmarks should also consider the robustness and reliability of the benchmarks they choose and ensure that they have reliable fallback mechanisms that can be used, in case their chosen benchmarks cease or become unrepresentative.
IOSCO supports the recent remarks of the Financial Stability Board (FSB) that "to ensure financial stability, benchmarks which are used extensively must be especially robust." Widespread use of, and transition to, credit-sensitive rates, instead of the U.S. Alternative Reference Rates Committee’s preferred Secured Overnight Financing Rate (SOFR), may therefore pose risks to financial stability. The IOSCO Board notes that SOFR provides a robust rate suitable for use in most products, with underlying transaction volumes that are unmatched by other alternatives. Users of benchmarks place considerable value on a benchmark being IOSCO compliant. To continue to give market confidence in the reliability and integrity of financial benchmarks, IOSCO will closely monitor how the IOSCO badge is used in compliance assessments of the relevant credit-sensitive rates.
Keywords: International, Banking, Securities, Interest Rate Benchmark, Credit Sensitive Rate, Benchmark Reforms, Risk Free Rate, LIBOR, USD LIBOR, SOFR, Derivatives, IOSCO
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