Dive Brief:

• Congress needs to pass legislation to help safeguard financial market stability during the transition from the London Interbank Offered Rate (LIBOR) to a new reference rate, Fed Vice Chair Randal Quarles told a U.S. House committee.

• Trillions of dollars in financial contracts using LIBOR lack adequate fallback language geared to post-LIBOR finance, Quarles testified yesterday to the House Financial Services Committee, adding “there’s really no way to address that other than legislation.” 

• “LIBOR is ending, it will not be able to be used, we believe it’s a safety and soundness concern for it to be used for new contracts after the end of this year,” Quarles said, adding the Fed "will supervise firms so their new contracts cannot be written on it.”

Dive Insight:

The Fed and other regulators in recent years have urged companies to switch to a new reference rate from LIBOR, the benchmark for trillions of dollars in securitizations, mortgages, business loans, derivatives and other financial contracts worldwide.

A botched transition from the benchmark could trigger market turmoil, the Financial Stability Oversight Council of U.S. regulators said in its annual report.

The U.K. Financial Conduct Authority, the administrator for LIBOR, announced in March that it will delay to mid-2023 the sunsetting of some of the most commonly used tenors of the benchmark rate.

The final fixings for most LIBOR rates — including 1-week and 2-month U.S. dollar LIBOR — will be made on Dec. 31, 2021, but other U.S. dollar tenors may continue until June 30, 2023.

Roughly $74 trillion in U.S. dollar LIBOR contracts are written to extend beyond June 2023, according to the Alternative Reference Rates Committee, which consists of the New York Fed, asset managers, banks and insurers.

Of these contracts, $6 trillion are bonds, notes, loans and other cash products “not designed with a permanent cessation of LIBOR in mind” according to the Securities Industry and Financial Markets Association (SIFMA).

Many of the contracts “are difficult or effectively impossible to amend, due to regulatory constraints or practical issues such as identifying all the holders of a widely distributed security,” SIFMA said. 

Legislation is needed to avert uncertainty and instability, Quarles added.

“Congressional action will be necessary,” he said. “Federal law would be an important part of how to address that tough legacy” of contracts extending beyond June 2023.

The Fed is not requiring companies to use a particular reference rate as an alternative to LIBOR, Quarles said. “The position of the Federal Reserve is that banks need to prepare for the transition, not that they must transition to a particular rate.”

Despite warnings from regulators since 2017, many companies have yet to switch to new reference rates, Quarles said in March, noting use of U.S. dollar LIBOR has increased to nearly $223 trillion in outstanding financial contracts from about $200 trillion in 2018.

The subcommittee on investor protection, entrepreneurship and capital markets is finalizing draft legislation to ease the transition of financial contracts from LIBOR.

The draft legislation closely tracks a recently passed New York law. Rep. Brad Sherman, D-Ca., chairman of the subcommittee, said last month he hopes the legislation is signed into law by the end of October.