Libor’s Delayed Demise Rewards Slow-Moving U.S. Bankers
(Bloomberg Opinion) -- When it comes to overseeing Wall Street, regulators must know that if they give an inch, banks and other large financial institutions will take a mile.
That’s part of the reason the years-long global effort to phase out the London interbank offered rate by the end of 2021 has been both impressive and nerve-wracking. On the one hand, the world’s policy makers have had more than three years to develop and adopt alternative lending benchmarks to replace Libor, which as of 2018 was tied to some $400 trillion of financial contracts. And yet, as recently as October, or roughly 14 months before Libor’s supposed demise, financial markets were spooked by the prospect of a “big bang” shift on interest-rate swaps to the top U.S. alternative: The secured overnight financing rate, or SOFR, which has gained some traction but is still just a sliver of Libor’s reach.
Perhaps because of the slow adoption of SOFR in the U.S. financial industry, the ICE Benchmark Administration on Nov. 18 raised the possibility that the dollar version of Libor could survive the Dec. 31, 2021, expiration date. On Monday, it went even further, announcing it’s considering extending the retirement of the key three-month dollar Libor tenor to June 30, 2023. It might also extend six-month and 12-month dollar Libor while sticking to its plan to cease publishing one-week and two-month Libor by the end of 2021.
At first glance, the move seems mostly technical. “Extending the publication of certain USD Libor tenors until June 30, 2023 would allow most legacy USD Libor contracts to mature before Libor experiences disruptions,” the IBA said in a statement. In a separate joint press release, the Federal Reserve, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency struck the same tone.
But reading between the lines, it’s hard not to wonder whether bankers will seize on this as an opportunity to once again put off switching from the rate that has dominated financial markets for nearly a half-century. While the official stance from U.S. regulators is that they’re calling for banks to stop writing new U.S. dollar Libor contracts by the end of 2021, the actual language remains somewhat squishy:
“The agencies encourage banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021. New contracts entered into before December 31, 2021 should either utilize a reference rate other than LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation. These actions are necessary to facilitate an orderly— and safe and sound— LIBOR transition. If the administrator of LIBOR extends the publication of USD LIBOR beyond December 31, 2021, the agencies recognize that there may be limited circumstances when it would be appropriate for a bank to enter into new USD LIBOR contracts after December 31, 2021.”
Yes, banks are “encouraged” to stop using Libor and they “should” use an alternative rate. And the regulators vow to “examine bank practices accordingly.” Bloomberg Intelligence analysts Ira Jersey and Angelo Manolatos say they don’t expect the transition to alternative rates to slow too much based on this announcement. But Libor is so accessible and so ubiquitous that it’s hard to imagine that banks will move with the same sense of urgency — and certainly not with any greater haste — if key tenors are extended through June 2023.
It’s understandable, of course, why regulators felt the finance industry needed more runway before Libor disappeared. As my Bloomberg Opinion colleague Mark Gilbert noted, banks and other institutions have clearly been slow to embrace the alternatives, with at least one survey of hedge funds, private equity firms and banks showing that one in five hadn’t even started down the path of making the transition. To further prove the point, Gilbert cited International Swaps and Derivatives Association data showing $96 trillion of dollar Libor swaps were traded this year, compared with $1.8 trillion for SOFR. It’s no contest.
The last thing financial regulators need coming out of a global pandemic that shook markets to their core is a mad dash to amend old Libor contracts and all the potential disruptions that come with that. The question is whether this move opens the door to further delays and backtracking. If hedge funds, private equity firms and banks continue to drag their feet on adjusting to a post-Libor reality, particularly in the U.S., will the authorities keep accommodating them?
It should not be lost on anyone that the amount of swaps tied to the U.K.’s SONIA interest rate benchmark in 2020 has eclipsed those in sterling Libor, $15.6 trillion to $12 trillion. At least in some regions, people are taking the end of the Libor era seriously. That’s seemingly why the IBA is comfortable moving ahead with its plan to cease the publication of all Libor settings for the British pound, the euro, the Swiss franc and the Japanese yen at the end of 2021. Yes, the dollar Libor market is bigger, accounting for roughly half of all the global contracts, but that doesn’t fully explain being this far behind in the transition.
The New York Fed, nestled in the heart of Wall Street, started a Twitter hashtag campaign, #LIBORsTickingClock, on Aug. 19, or 500 days until the end of Dec. 31, 2021. “NASA says it may take 500 days (or longer!) to go to Mars and back. No time to become an astronaut? You can prepare for the transition away from LIBOR instead!”
The “or longer!” turned out to be prescient — and exactly what late adopters were counting on.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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