No Delay for US Dollar LIBOR

ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

It’s tempting to look at the June 30, 2023 date set for the death of most US dollar LIBOR settings and see it as an 18-month delay. That is not the case. In fact, firms need to prepare to use alternative reference rates for most new trades from the start of next year, irrespective of which LIBOR they use.

Following announcements on March 5 by the UK Financial Conduct Authority (FCA) and LIBOR’s administrator, ICE Benchmark Administration, market participants now have certainty and clarity over the timing for LIBOR’s demise. We know 30 LIBOR settings (all non-US dollar tenors plus one-week and two-month US dollar LIBOR) will either cease or become non-representative after December 31, 2021. We also know the remaining five US dollar LIBOR settings will continue to be published on a representative basis until June 30, 2023.

Despite the extra 18 months for overnight, one-month, three-month, six-month and 12-month US dollar LIBOR, however, it is clear that firms cannot afford to take their foot off the gas when it comes to transition. It is also clear that these US dollar LIBOR settings will cease or become non-representative after the middle of 2023, without the possibility of any extension.

While the mid-2023 end date for most US dollar LIBOR settings means roughly two thirds of existing exposure will roll off naturally, US regulators have been very clear that US-supervised entities should stop using US dollar LIBOR for new trades after the end of 2021. There are a few exceptions to this – for example, new transactions that reduce or hedge existing US dollar LIBOR exposure will be allowed – but the direction of travel is unambiguous.

Speaking at an event hosted by the Alternative Reference Rates Committee (ARRC) last month, Randal Quarles, the Federal Reserve’s vice chair for supervision, was blunt. “As with the statements about LIBOR’s end, there should be complete certainty about this guidance from US regulators: 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.”

US regulators aren’t the only ones that could clamp down on US dollar LIBOR. Under proposed new powers set out in the Financial Services Bill, which is currently making its way through the UK parliament, the FCA would be able to prohibit new use of a critical benchmark that is going to cease.

Speaking at the ISDA Benchmark Strategies Forum earlier this month, Edwin Schooling Latter, director of markets and wholesale policy at the FCA, suggested that could include US dollar LIBOR. “There is a clear expectation that use of dollar LIBOR in new contracts should stop by the end of this year, here, in the US, and in other key jurisdictions,” he said.

Other regulators and national benchmark working groups are also rolling out their own deadlines for halting new use of LIBOR. Even where firms are not directly affected by regulatory edicts, the ability to trade products linked to US dollar LIBOR will likely be impaired as supervised banks pull back.

The unavoidable conclusion is that firms need to be ready to use alternatives to US dollar LIBOR for most new trades by end-2021. Progress is being made, and liquidity in alternative risk-free rates (RFRs) is growing, but there’s still a long way to go. According to the latest data by ISDA and Clarus, just 4.7% of cleared over-the-counter and exchange-traded US dollar interest rate derivatives DV01 was referenced to SOFR in March.

Of course, RFRs aren’t the only options out there. A number of other alternatives to US dollar LIBOR have emerged, including some with a credit spread component meant to reflect the dynamics of bank lending markets.

For our part, ISDA is agnostic on the alternative rates that are ultimately used. But whichever option is chosen, firms shouldn’t leave the switch until the last minute.

We ultimately expect liquidity in SOFR and other alternatives to US dollar LIBOR to steadily increase as we approach the 2021 deadline. Transition milestones set by the ARRC will likely help. For example, it has set a best practice target for firms to stop new use of US dollar LIBOR in derivatives, business loans and most securitizations that mature after the end of 2021 from June 30.

But time is short – there’s only eight months until the end of 2021. Firms should use it wisely.

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