Banks, “as soon as practicable,” should cease entering into new contracts that employ a widely used reference rate that is being phased out, the three federal banking agencies in a statement issued Monday.
The recommendation is being made, the agencies said, in order to facilitate an orderly – and safe and sound – transition to alternative reference rates.
Meanwhile, the administrator of the soon-to-be-defunct reference rate also Monday proposed a plan to cease publishing the U.S. dollars version of the rate at the end of next year.
The Federal Deposit Insurance Corp. (FDIC), Federal Reserve, and the Office of the Comptroller of the Currency (OCC) issued the joint statement on managing the transition away from the London Interbank Offer Rate (LIBOR), which is widely used by financial institutions as a reference rate for adjustable-rate mortgages and other loan contracts. The rate is being phased out because the transactions it is based on don’t occur as often as they did in prior years.
In the statement, the three agencies said the rate should not be used for new contracts and, in any event, not following Dec. 31, 2021, after which regulators have said they can no longer guarantee production of the rate.
The statement is the second on the subject of LIBOR transition to be issued by the agencies this month. In early November, the three banking agencies issued a statement urging banks to begin working “without delay” toward the transition. The agencies also said in that statement that a bank may use any reference rate for its loans that the bank determines to be appropriate for its funding model and customer needs.
Monday’s statement went a bit further than the early November announcement, recommending against the use of LIBOR in new contracts.
“Given consumer protection, litigation, and reputation risks, the agencies believe entering into new contracts that use USD LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and will examine bank practices accordingly,” the agencies wrote. “Therefore, 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.”
The agencies said that new contracts entered into before Dec. 31, 2021 should either use a reference rate other than LIBOR or have “robust fallback language that includes a clearly defined alternative reference rate after LIBOR’s discontinuation.”
However, the statement does signal some wiggle room for LIBOR, if the administrator of the rate (based in the United Kingdom) determines to extend the publication of USD LIBOR beyond the end of next year. The agencies wrote that if the publication of USD LIBOR is extended, “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.”
Those circumstance include, the agencies said:
- transactions executed for purposes of required participation in a central counterparty auction procedure in the case of a member default, including transactions to hedge the resulting USD LIBOR exposure;
- market making in support of client activity related to USD LIBOR transactions executed before Jan. 1, 2022;
- transactions that reduce or hedge the bank’s or any client of the bank’s USD LIBOR exposure on contracts entered into before Jan. 1, 2022; and novations (substitutions of new contracts in place of old ones) of USD LIBOR transactions executed before Jan. 1, 2022.
Also Monday, the administrator of LIBOR – Intercontinental Exchange (ICE) – proposed a plan to cease publishing U.S. dollar LIBOR after the end of 2021. According to the group, under the plan, publication of the one-week and two-month settings of USD LIBOR would end immediately after Dec. 31, 2021; remaining LIBOR settings would cease publication on June 30, 2023. That would provide time, the group said, for most legacy LIBOR-referencing contracts to mature. ICE wants feedback on its plan by the end of next January.