Calls Grow for Regulation in LIBOR Transition

Representatives from U.S. financial regulators testified at a recent House Financial Services committee hearing on the transition away from LIBOR to an alternative interest rate for derivatives and other financial products. The ICE Benchmark Administration this year confirmed its plan to end the use of LIBOR, with the majority of non-U.S. Dollar LIBOR settings ceasing on December 31, 2021 while U.S. Dollar denominated LIBOR will end on June 30, 2023. According to the House Committee memo, the Financial Stability Oversight Council (FSOC) has identified the “cessation of degradation of LIBOR” as having the potential to “significantly disrupt” financial markets. In a statement the General Counsel of the Federal Reserve System contended that a key question is whether existing LIBOR-based contracts (legacy contracts) can seamlessly transition to alternative reference rates when LIBOR ends. Some legacy contracts have adequate fallback language to address the end of LIBOR, but others do not. In a posting on its web site, industry trade group SIFMA outlined several potential problems that would not be solved by LIBOR’s cessation date and noted that even with fallback language the outcome of LIBOR cessation could “lead to vast amounts of litigation that ties up courts for years and [cause] major disruption in financial markets and investor portfolios.” For example, SIFMA’s top official wrote: “There are tens of thousands of floating-rate securitization and corporate bond transactions.  Some contracts do not have fallbacks. More commonly, the fallback provisions would result in a floating-rate bond becoming a fixed-rate bond. Other contracts fall back to the judgment of an issuer, administrator, or other party.” SIFMA’s note warned that these issues have real world impact as these instruments are held by mutual funds, pension funds, and 401k plans. According to the Capitol Hill statement from the Fed’s general counsel, Fed Chairman Powell and Vice Chair Quarles have publicly stated their support for federal legislation to mitigate risks related to legacy contracts. “Federal legislation would establish a clear and uniform framework, on a nationwide basis, for replacing LIBOR in legacy contracts that do not provide for an appropriate fallback rate.” Proposed legislation included in the House Committee memo would “establish a process for certain financial contracts that reference LIBOR and do not contain sufficient language that would allow them to continue to function as originally intended after LIBOR is discontinued.”