For years, the London Interbank Offered Rate (Libor) set the benchmark for global interest rates and impacted trillions of dollars in financial activity, leading many to call it as “the world’s most important number.” However, following controversies and reform efforts after the 2008 financial crisis, regulators in the United States and United Kingdom began exploring a replacement benchmark rate system. In the UK, the Financial Conduct Authority announced in 2017 that after 2021, banks would no longer be compelled to submit the data required to populate Libor. In the US, financial regulators have been working closely with industry groups and other stakeholders to establish a new system to replace Libor.
As broker-dealers and financial services firms prepare for this transition, Haimera Workie and Richard Vagnoni from FINRA’s Office of Financial Innovation sat down for three separate conversations about the implications of the change, how regulators are approaching the issue and what firms should be doing to prepare for possible life after Libor.
Why is Libor Disappearing?
In our first interview, former Chairman of the Commodity Futures Trading Commission Tim Massad discusses how and why the transition from Libor came about. He gives an overview of the controversies that led US regulators to begin moving away from Libor, including conflicts of interest investigations, manipulation of Libor and the inherent shortcomings of an index that is based, in part, on subjective human estimates. Tim also highlights how reform efforts in the US have attempted to improve accountability and transparency and how ultimately, transitioning to a new benchmark rate can bring a system with better governance and integrity.
Where Does Industry Go from Here?
For our second segment, Anthony Murphy from Promontory Financial Group sits down to discuss the implications of transitioning away from Libor for products and industry segments. He outlines challenges that firms are grappling with and how they are responding. He also dives deeper on the creation and work of the Alternative Rates Reference Committee (ARRC), an industry committee created by the Federal Reserve. Notably, in 2017, the ARRC selected the Secured Overnight Financing Rate (SOFR) as the preferred US replacement to Libor. Tony illustrates some of the ARRC’s considerations in making that selection and the potential pathway forward for implementation of SOFR.
From Libor to SOFR: How are Regulators Preparing for the Change?
In our last installment, we hear from policy experts at the Securities & Exchange Commission. Senior Policy Advisor in the Division of Trading & Markets David Metzman and Assistant Director of Risk Supervised Broker-Dealer Program Michelle Danis talk about regulators’ approach to the potential transition, both in policy and in guiding industry participants. They provide insights on work the SEC is conducting with stakeholders to navigate possible impacts of a potential change to SOFR, along with key considerations they have put forth for broker-dealers and other industry firms. In particular, Michelle highlights the need to update contractual fallback language to include references to benchmark rates other than Libor. She also discusses how firms need to examine their IT systems to ensure they are incorporating new reference rates. Finally, they cover prudent steps all firms should take to prepare for implementation of SOFR.