Work needs to accelerate early next year to move away from an obsolete reference rate used as a benchmark in some loans, a report issued Friday by an international group of financial regulators said, noting that discarding the rate in favor of alternatives “remains a significant priority.”
The “progress report” on the replacement of the London Interbank Offered Rate (LIBOR) was issued by the Financial Stability Board (FSB), an international group of authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts. It is now chaired by Federal Reserve Board Vice Chair for Supervision Randal Quarles.
The report stated that moving away from LIBOR “needs to accelerate further” in early 2021. “Continued engagement from the private sector in conjunction with a significant commitment by the official sector is critical in order to support this transformational effort,” it added.
LIBOR, which is widely used by financial institutions as a reference rate for adjustable-rate mortgages and other loan contracts, is being phased out because the transactions it is based on don’t occur as often as they did in prior years. In fact, the report issued Friday states that “production of LIBOR cannot be guaranteed after the end of 2021.”
The report notes that, in 2020, disruption to global financial markets caused by the coronavirus crisis has further highlighted the fundamental weaknesses in LIBOR. The report states that has reinforced the “critical importance of the FSB’s efforts to reform the production and use of global interest rate benchmarks.”
The report further asserts that, with only one year left until end-2021, “all market participants – both financial and non-financial firms across the globe – must now ensure they follow the necessary steps to avoid disruption to the performance of their contracts” due to the phase-out of LIBOR.
The FSB said that winding down LIBOR will require steps to stop issuance of new products linked to LIBOR and efforts to transition away from LIBOR in legacy contracts wherever feasible. “Due to the widespread use of LIBOR around the world, steps to assess exposures, update processes and amend contracts must be taken by a very wide range of firms, across all jurisdictions,” the report states.
The report bluntly states that, for the transition away from LIBOR to occur on time, market participants will need to cease use of the rate as a benchmark in all new activity across global markets as soon as possible. “This needs to be a key priority for the months ahead,” the report states.
The report acknowledges that “tough legacy” contracts that cannot feasibly transition away from LIBOR by the end of 2021 are the subject of some proposed solutions. However, the report stressed that the “importance of active market-led transition remains.”
“There have been a number of proposals by authorities and national working groups including in the US, UK [United Kingdom] and EU [European Union] to help manage an orderly wind-down of LIBOR and, in particular, provide a legislative solution for tough legacy contracts,” the report states. “However, market participants should continue to progress their transition efforts and plans proactively, particularly through active conversion and the insertion of robust and workable fallbacks where feasible. Cooperation among authorities internationally is also encouraged in order to coordinate proposed solutions across borders.”
2020 FSB Progress Report: The year of transition away from LIBOR