Quarles on the end of LIBOR

On October 5, Federal Reserve Board Vice Chair for Supervision Randal K. Quarles spoke at The Structured Finance Association Conference in Las Vegas on "Goodbye to All That: The End of LIBOR."

Quarles reminded his audience that while LIBOR will no longer be a functional index after June 30, 2023, it will not be available for use in any new contracts after the end of 2021 — just 85 days from today. The Federal Reserve and other regulators have made it clear they will focus clearly on whether their supervised institutions stop new use of LIBOR by the end of this year. After that date, the only use for LIBOR will be as an index for older contracts, which should be maturing by June 2023. "Otherwise," said Quarles, "many banks would have had to re-negotiate hundreds of thousands of loan contracts before December 31, an almost impossible task."

"But the whole process only works", Quarles added, "if no new LIBOR contracts are written while the legacy contracts are allowed to mature. So, those new LIBOR contracts will not be made. Change is difficult, but it is inescapable."

Driving his point home, Quarles said, "A handful of firms have said that they may want more time to evaluate potential alternative rates. There is no more time, and banks will not find LIBOR available to use after year-end no matter how unhappy they may be with their options to replace it. I would note that the [Alternative Reference Rates Committee (ARRC)] has been publishing tools to facilitate the use of [the Secured Overnight Financing Rate (SOFR)] for almost four years. SOFR is a broad measure of the cost of borrowing cash overnight, collateralized by Treasury securities. It rests on one of the deepest and most liquid markets in the world. It is calculated transparently by the Federal Reserve Bank of New York, engendering market confidence. And it can be used for all types of transactions. Notably, the ARRC recently recommended SOFR term rates, which will facilitate the transition from LIBOR to SOFR for market participants who wish to use a forward-looking rate. Given the availability of SOFR, including term SOFR, there will be no reason for a bank to use LIBOR after 2021 while trying to find a rate it likes better."

As for loans, Quarles offered, "Loans, however, are different from derivatives and capital markets products, and raise different issues. With respect to loans, the Federal Reserve, OCC, and FDIC issued a letter last year explaining that we have not endorsed a specific replacement rate. We have not changed that guidance. A bank may use SOFR for its loans, but it may also use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs. But a bank will not find LIBOR available after year-end, even if it doesn't want to use SOFR for loans and hasn't chosen a different alternative reference rate. Reviewing banks' cessation of LIBOR use after year-end will be one of the highest priorities of the Fed's bank supervisors in the coming months. If market participants do use a rate other than SOFR, they should ensure that they understand how their chosen reference rate is constructed, that they are aware of any fragilities associated with that rate, and—most importantly—that they use strong fallback provisions."