Confusion reigns as US prepares for Libor’s end

Mixed messages from US regulators make it more difficult to plan for life after Libor

The average US dollar Libor user can be forgiven for being a little confused about what comes next.

Regulators have called for no new Libor contracts to be written after the end of this year, though the discredited benchmark will continue to be available for use in existing contracts until mid-2023.

The Federal Reserve-backed working group tasked with ushering US markets off Libor has said it wants to see a “vibrant and innovative market” for reference rates emerge in its place. But regulators have made no secret of their preferred option – the secured overnight financing rate, or SOFR – even going so far as to describe some private-sector alternatives as “flawed”.

The back-and-forth over the availability of a forward-looking term SOFR hasn’t helped. In March, the Alternative Reference Rates Committee warned that low liquidity in overnight SOFR derivatives could push the timeline for a term version beyond 2021. Two months later, CME was named as the official provider of a term SOFR rate, though the ARRC stopped short of giving it the full endorsement necessary for use in regulator-backed fallbacks for cash products. That is expected to come in late July or early August. But as it stands, the term SOFR rate may not be available for use in derivatives for another two years.

That creates an odd situation. CME will not offer futures or swaps clearing linked to its officially endorsed term SOFR rate until June 2023, or even later. But the exchange plans to launch a futures contract referencing Bloomberg’s short-term bank yield index, or BSBY – which has been severely criticised by regulators – before the end of September, with clearing of BSBY swaps slated for year-end.

Regulators have even gone so far as to describe some private-sector alternatives as “flawed”

All of this shows how little control US regulators have over the Libor transition. In the absence of anything comparable to the European Union and UK’s benchmarks regulation (BMR), they have no real power to prohibit the use of benchmarks that meet vaguely defined international standards.

Confoundingly, the UK’s Financial Conduct Authority may have more influence over some SOFR alternatives than US regulators. Ice Benchmark Administration, which administers Libor and is developing its Bank Yield Index as an alternative, CME Group Benchmark Administration, the official term SOFR provider, and Bloomberg Index Services, which publishes BSBY, are all regulated by the FCA under the UK’s BMR.

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Bank of England governor Andrew Bailey has said publicly that some of these benchmarks pose “a range of complex longer-term risks”. It is perhaps little surprise then that BSBY is not authorised for use in the UK. But that hasn’t prevented the rate from being used in US transactions.

In the US, the market will decide what comes after Libor, and the regulators’ efforts to micro-manage the outcome have only served to complicate matters. A recent survey by consulting firm SIA Partners found that confused messaging around timelines and reference rate options was a top transition concern among the roughly 50 respondents, including banks and end-users.      

There’s a lot to be cleared up in the next six months before US dollar Libor disappears in the rear-view mirror. Exactly what cash products and their associated hedges will reference in its place remains something of a mystery. Regulators need to sharpen their messaging and focus on what they control to ensure an orderly transition to a post-Libor market.

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