October 11, 2018

Bipartisan Policy Center “Reference Rate Reform: Impact on the Economy and Consumers”

Key Takeaways

  • Transitioning from LIBOR: SEC Chairman Jay Clayton discussed what a “big job” transitioning from the London Inter-Bank Offered Rate (LIBOR) to a new reference rate will be, as the rate will be used throughout the economy at a global level. Clayton explained that one way to ensure a less “bumpy” transition is by the alternate rate picking up traction in the near-term and being used in new transactions so there will be less concern about the new rate from market participants.
  • Fallback Language: ISDA’s Scott O’Malia stated that ISDA is currently working with other trades on fallback language, and that while the deadline for derivative fallback consultation was set to end today, ISDA has extended the deadline to October 22 to ensure they receive robust feedback and broad, market-wide adoption.
  • Using SOFR: MetLife’s Jason Manske noted the need for regulators to ease the transition by not penalizing end users from transitioning to products like derivatives linked to the Secured Overnight Financing Rate (SOFR), as legacy contracts linked to LIBOR should move earlier rather than wait until a trigger event. 

Speakers

  • The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission
  • John Harwood, Editor at Large, CNBC
  • Scott O’Malia, Chief Executive Officer, The International Swaps and Derivatives Association
  • David Bowman, Senior Advisor to the Board, Board of Governors of the Federal Reserve System
  • Jack Hattem, Managing Director, Global Fixed Income, BlackRock
  • Alice Wang, Managing Director, Global Head of CIB Operational Risk, JPMorgan Chase & Co.
  • Doug Elliott, Partner, Oliver Wyman
  • Meredith Coffey, Executive Vice President of Research & Regulation, The Loan Syndications and Trading Association
  • Sairah Burki, Senior Director, Policy, The Structured Finance Industry Group, Inc.
  • Wells Engledow, Vice President & Deputy General Counsel, Fannie Mae
  • Jason Manske, Senior Managing Director & Chief Hedging Officer, MetLife
  • The Honorable Rostin Behnam, Commissioner, U.S. Commodity Futures Trading Commission

Discussion with SEC Chairman Jay Clayton

Transition to a New Reference Rate

During a discussion with John Harwood, Editor at Large, CNBC, Clayton discussed what a “big job” transitioning from the London Inter-Bank Offered Rate (LIBOR) to a new reference rate will be, as the rate will be used throughout the economy at a global level. Clayton explained that one way to ensure a less “bumpy” transition is by the alternate rate picking up traction in the near-term and being used in new transactions so there will be less concern about the new rate from market participants. He stressed the need for market participants to see that this new reference rate will be better for them, adding that there needs to be more public education on how the markets work and how this change could impact them (through their mortgage, credit card, student loans, etc.).

Private and Public Companies

Clayton explained that due to the shift into defined contribution plans and investors being responsible to save for their retirement, there has been broader household participation in the markets, but that he would like to see it even more broad. He noted that there are fewer public companies today due to companies waiting longer in their life cycle to go public, resulting in retail investors having less access to the market, adding that the SEC is trying to make public capital markets more attractive.

Quarterly Reporting Requirements

Regarding President Trump’s request for the SEC to review quarterly reporting requirements, Clayton explained that while it is a good point to raise, quarterly reporting will not change “anytime soon” for larger institutions, though it could make sense for the SEC to review if smaller companies should report less frequently to lift compliance burdens.

Blockchain and Cryptocurrencies

When asked by an audience member about blockchain technology, Clayton replied that his issue with decentralization is a lack of assigned responsibility. He also explained that he has conversations with international regulators, such as the Financial Stability Board (FSB) and International Organization of Securities Commissions (IOSCO), on crypto assets, explaining that “the need for international cooperation is great.” Regarding fraud in cryptocurrency, Clayton explained that if fraudsters think they can financially gain quickly, and the market remains unregulated, “it’s a fertile ground for fraud.”

SIFI Designation

When asked if there are certain types of activities he is worried about leading to the designation of systemically important, Clayton explained that he is always looking for activities that would cause risk to the U.S. or global financial system, and that forums like the Financial Stability Oversight Council (FSOC) are great places to have these discussions. He noted that he always remains forward thinking, as risks from the past could give an indication of the future but will never be the same.

Market Data

When asked about the sale of market data, Clayton explained that while he does not have a definitive view on the sale of market data by regulated exchanges, it is an area the SEC should look at and that the Commission hears from stakeholders on this.

Panel 1 Discussion

Transitioning from LIBOR

Scott O’Malia from ISDA moderated a discussion about the movement from LIBOR to a new reference rate, the Secured Overnight Financing Rate (SOFR). David Bowman from the Federal Reserve gave an overview of the history of LIBOR and why there is a need to move away from this rate, noting that five different currencies currently use LIBOR, with U.S. dollar being the largest market. He then discussed the creation of the Alternative Reference Rates Committee (ARRC) that was tasked with finding an alternative rate more appropriate for the markets, and their recommendation to move from LIBOR to SOFR.

Alice Wang from JPMorgan Chase noted that the new risk-free rate is different from LIBOR because ARRC subcommittee participants from the marketplace have been involved in discussions and the transition process, and that the more industry works together with customers, the better the result will be.  Jack Hattem from BlackRock explained that the market needs to be aware of the transition and there needs to be an assessment stage where exposures to LIBOR can be quantified, as LIBOR can be found throughout the economy. He stressed the need for education and awareness, noting that the buy-side is currently evaluating fallbacks for existing documents and creating new fallback language for future documents.

Scope of Exposure

When asked about the scope of exposure, Bowman explained that floating rate mortgages and private student loan debt referencing LIBOR will have the biggest consumer exposure, adding that the ARRC is “working to treat consumer products with the most sensitivity” and has reached out to advocacy groups to create a robust transition process to ensure consumers are heard.

Fallbacks

Hattem stated that having updated fallback definitions would ease the transition to SOFR, and O’Malia added that ISDA is currently working with other trades on fallback language. He continued that while the deadline for derivative fallback consultation was set to end today, ISDA has extended the deadline to October 22 to ensure they receive robust feedback and broad, market-wide adoption.

In response to an audience question about whether fallback language in contracts could be written broader, such as including “either/or” when it comes to reference rates, Bowman stressed the importance of the process being as “smooth and fair to consumers” as possible, and that sometimes giving consumers too much choice can be confusing for them.

Panel 2 Discussion

Issues Moving from LIBOR

Doug Elliott from Oliver Wyman moderated the second panel and discussed some of the issues the industry will face, to include litigation risks if the Financial Conduit Authority (FCA) and UK state LIBOR is no longer an adequate rate and industries continue to use it. Meredith Coffey from the Loan Syndications and Trading Association explained that one of the ARRC working groups has put out a consultation with recommendations on how fallback language should look for syndicated loans, noting that the focus was on making recommendations that are workable, can be executed broadly, reduce systemic risk and be as fair as possible.

Coffey noted that SOFR is a secured rate in contrast to unsecured LIBOR which includes a credit risk component, and that there have been discussions about a dynamic credit spread adjustment (as opposed to a static adjustment), though it was decided that a dynamic adjustment would not be practical, adding that this is one of the issues industry will have to acknowledge when moving to a “better, more robust rate.”

Sairah Burki from the Structured Finance Industry Group also discussed fallback language and how there are unique aspects of securitization coming down to the multitude of moving parts of a transaction, including securities, underlying collateral, and derivatives hedging the deals, and how her members are focused on moving toward forward-looking risk-free rates. She noted that the ARRC has a floating notes rate group and securitization working group that are dealing with pre-cessation triggers and “figure[ing] out moving pieces.”

In response to an audience question about fallback language, Burki explained that it should be as market-based and best practices-driven as possible, because as the markets evolve it is expected industry participants will update their policies and procedures moving forward. 

Using SOFR

Jason Manske of MetLife explained that MetLife issued a SOFR-linked liability over the summer but that there is more work to be done to develop the markets, with education being key. He also noted the need for regulators to ease the transition by not penalizing end users from transitioning to products like derivatives linked to SOFR, as legacy contracts linked to LIBOR should move earlier rather than wait until a trigger event.

Wells Engledow from Fannie Mae explained that Fannie issued a floating rate note in markets indexed to SOFR in July after a lengthy process of speaking to dealers and investors, as well as ensuring Fannie was operationally ready. He continued that the note was “very well received” and “went really well,” though there were a handful of “pesky” operational issues and “more legal focus than you could imagine.”

Closing Remarks by CFTC Commissioner Rostin Behnam

In his closing remarks, Behnam stressed how “crucial” reference rates are to the global economy and how “woven” they are in “countless” products. He explained how reference rate reform will require an “all hands on deck approach” to make sure consumers do not suffer from manipulated reference rates. Behnam continued that the CFTC has been participating in the Official Sector Steering Group created by the FSB to drive the reference rate reform, and that with only a few years before the 2021 timeframe when banks will no longer be compelled by the FCA to submit to LIBOR, consensus must be made, and foundations laid for LIBOR’s replacement.

Behnam then discussed how the CFTC’s Market Risk Advisory Committee (MRAC) has been focused on benchmark reform since July, and that since then there have been discussions with members of the ARRC and market participants on LIBOR reform, to include the development of SOFR, SOFR derivatives, and ways to improve LIBOR. He continued that last week the CFTC approved the creation of an Interest Rate Benchmark Reform Subcommittee that will provide recommendations to the MRAC regarding transition efforts, the treatment of existing derivative contracts to include new fallback language regarding SOFR and other risk-free rates. Behnam concluded by stating he is determined to rebuild trust and facilitate bipartisan conversations to resolve issues in the derivatives markets.

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