In the clearest terms expressed by any regulator to date, Federal Reserve Vice Chairman for Supervision Randal Quarles emphasized that banks need to begin transitioning away from the London Interbank Offered Rate as a benchmark. “Regardless of how you choose to transition, beginning that transition now would be consistent with prudent risk management and the duty that you owe to your shareholders and clients,” he said in prepared remarks for a roundtable hosted by the Alternative Reference Rates Committee in New York.
Quarles noted that the ARRC has developed Libor fallback language for a variety of financial instruments, and he encouraged market participants to implement this language. He added that an “easier path . . . is simply to stop using Libor.” Relying on fallback language “brings a number of operational risks and economic risks,” he explained. “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.”
Quarles provided additional details on the Fed’s supervisory approach to the reference rate transition, including that the agency will expect to see “an appropriate level of preparedness at the banks we supervise . . . and that level must increase as the end of 2021 grows closer.” He also responded to concerns that the Fed’s supervisory stress tests might penalize banks that replace Libor with the ARRC’s recommended alternative, the Secure Overnight Financing Rate. “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 the Federal Reserve,” he said.
The event hosted by the ARRC—a group of market participants convened by the Fed—also included presentations on how to use SOFR, the development of fallback language and transition steps firms should be taking now. American Bankers Association VP Hu Benton, who represents the association on the ARRC, spoke at the event.