The Alternative Reference Rates Committee ("ARRC") held a roundtable on June 3, 2019. The ARRC hosted a number of industry participants, and the program was introduced with a speech by Randal K. Quarles, Vice Chair for Supervision, Board of Governors of the Federal Reserve System.1

Chair Quarles emphasized that issuers should be transitioning to using the new fallbacks for U.S. dollar LIBOR floating rate notes ("FRNs") published by the ARRC on April 25, 2019 as a matter of prudent risk management.2 However, simply issuing U.S. dollar LIBOR FRNs, even with the new fallback language, is not a path that the regulators unreservedly support. Chair Quarles and Tom Wipf, Chair of the ARRC, both said that there is still a risk of value transfer at the time that a LIBOR FRN transitions over to the replacement rate, even with the ARRC final fallback language included. Chair Wipf referred to the ARRC fallbacks as a "safety belt," and Chair Quarles noted that relying on the fallback language brings operational and economic risks. Both speakers indicated that decisions to issue LIBOR FRNs may be questioned in hindsight.

Chair Quarles also went one step farther, stating that "[t]here is, however, also another and easier path, which is to simply stop using LIBOR." It's clear that bank regulators are very focused on limiting risk to bank issuers from LIBOR issuances, and will be asking questions of banks that continue to issue U.S. dollar LIBOR FRNs.

It was emphasized that Term SOFR may not be ready by the time LIBOR is expected to cease in 2021, so market participants were encouraged not to wait for it. Term SOFR would be a forward-looking term rate, much like LIBOR is now, and is also the first choice in the waterfall of replacement rates in the ARRC fallbacks. There was also strong encouragement to the private market to consider more SOFR issuances, using compounded average SOFR. The rationale behind this is that the more SOFR issuances there are, the deeper the derivatives market will be, thus providing data to create a viable IOSCO-compliant Term SOFR in the future.

For legacy LIBOR FRNs that mature after LIBOR is expected to cease and have the existing fallbacks from the 2006 ISDA Definitions, which will cause these notes to become fixed rate notes when LIBOR ceases, a potential legislative solution is being investigated, but no definite approach has been finalized as of yet.

Footnote

1 Chair Quarles's speech is available at: http://bit.ly/2XzzDqr.

2 Our Legal Update on the ARRC's Recommendations Regarding More Robust Fallback Language for New Issuances of LIBOR Floating Rate Notes is available at: http://bit.ly/2ZMviO8.

Originally published in REVERSEinquiries: Volume 2, Issue 6.
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