Dive Brief:

• Federal Reserve Vice Chair Randal Quarles called for a halt in the use of the London Interbank Offered Rate (LIBOR) in new financial contracts, saying the creation of such agreements poses “safety and soundness concerns after 2021.”

• “If supervised firms are not making adequate progress in transitioning away from LIBOR, examiners should consider issuing supervisory findings or taking other supervisory actions,” Quarles said in a March 22 speech.

• Quarles expressed concern that, despite repeated warnings from regulators since 2017, use of U.S. dollar LIBOR has increased to nearly $223 trillion in outstanding financial contracts from about $200 trillion in 2018.

Dive Insight:

Regulators in the U.S., U.K. and other countries have urged companies to switch to alternative rates from LIBOR, the reference rate for trillions of dollars in mortgages, business loans, derivatives and other financial contracts worldwide.

The U.K. Financial Conduct Authority, LIBOR's administrator, announced this month 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.

“There is no scenario in which a panel-based USD LIBOR will continue past June 2023, and nobody should expect it to,” Quarles said. “There should be complete certainty about” U.S. regulatory guidance. After 2021, we believe that continued use of LIBOR in new contracts would create safety and soundness risks, and we will examine bank practices accordingly.”

Companies face big challenges in phasing out the reference rate. LIBOR is woven into core operations such as valuation, accounting, tax and debt management. Some debt instruments are held by hundreds of investors who will need to agree on any modifications.

A flawed LIBOR transition could jeopardize market stability, the Financial Stability Oversight Council of U.S. regulators said in its annual report.

Regulators will scrutinize banks' plans to switch to alternative reference rates, Quarles said, warning of potential regulatory consequences for slow-acting institutions.

“What is most important this year is that firms should end new use of LIBOR,” Quarles said. “The firms we supervise should be aware of the intense supervisory focus we are placing on their transition, and especially on their plans to end issuance of new contracts by year-end.”

Adoption of the alternative reference rate favored by the Fed and other U.S. regulators — the Secured Overnight Financing Rate (SOFR) — has accelerated during the past several months, but is far from eclipsing LIBOR.

SOFR is based on overnight repurchase agreements secured by Treasuries and, unlike LIBOR, does not enable treasurers to make forward-looking rate calculations. LIBOR is based on London banks' estimates of what they would be charged when borrowing from other banks.

Recent U.S. and U.K. regulatory announcements “are meant to completely end the new use of LIBOR while allowing a significant portion of legacy contracts to roll off before the key dollar LIBOR tenors stop publication,” Quarles said.

An estimated $90 trillion in financial contracts will not mature before June 2023, Quarles said, adding “many still have no effective means to replace LIBOR upon its cessation.”

Legislation is needed by either New York or Congress to ensure such contracts are handled appropriately, Quarles said, adding “we cannot take any legislative solution for granted until it becomes law.”

Phasing out LIBOR may prove especially challenging with U.S. collateralized loan obligations, student loan asset-backed securities and financial contracts with weak fallback language maturing after 2021, Moody’s Investors Service said in a report.