Quarles: SOFR Meets Regulatory Due Diligence Requirements

Regulatory agencies will expect banks to conduct thorough due diligence on the reference rates they use, but the Secured Overnight Financing Rate recommended as a replacement for the London Interbank Offered Rate has already undergone that due diligence, Federal Reserve Vice Chairman for Supervision Randal Quarles said at a public event today on the transition from Libor.

“Banks should conduct at least as much due diligence on the reference rates that they use as they conduct on the creditworthiness of their borrowers,” Quarles said. “The national working groups convened by many of the [Financial Stability Board] member authorities have performed that type of diligence with SOFR and the risk-free rates identified in other jurisdictions.” SOFR is the preferred IOSCO-compliant alternative to Libor identified by the Alternative Reference Rates Committee.

“We have only a little over two and a half years until the point at which LIBOR could end, and the transition needs to continue to accelerate,” said Quarles, who convened the forum in his role as chairman of the Basel, Switzerland-based FSB. “The Federal Reserve will expect to see an appropriate level of preparedness at the banks it supervises.” American Bankers Association President and CEO Rob Nichols participated in the meeting to share the perspectives of ABA members on the Libor transition, supplementing ABA’s participation in transition planning through the ARRC.

With Libor—which underpins $200 trillion in U.S. dollar-denominated financial instruments—not guaranteed to be sustained after 2021, participants in the forum highlighted substantial progress made in transitioning away from Libor. One key development that needs to take place is the development of term structures for alternative rates, said U.K. Financial Conduct Authority CEO Andrew Bailey, who supervises Libor. While he was confident these would happen as a result of the work done thus far, he added that they “are not going to emerge by fiat. . . . They’re going to emerge by use.”