Randal Quarles of FED on Next Stage in Transition Away from LIBOR
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
Featured Experts
James Partridge
Credit analytics expert helping clients understand, develop, and implement credit models for origination, monitoring, and regulatory reporting.
Laurent Birade
Advises U.S. and Canadian financial institutions on risk and finance integration, CCAR/DFAST stress testing, IFRS9 and CECL credit loss reserving, and credit risk practices.
Emil Lopez
Credit risk modeling advisor; IFRS 9 researcher; data quality and risk reporting manager
Previous Article
APRA Decides to Increase Loss-Absorbing Capacity of D-SIBsRelated Articles
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.