IOSCO Urges Market Participants to Assess Exposure before End of LIBOR

IOSCO urged market participants to assess their exposure in preparation for USD LIBOR's anticipated cessation.

In its statement, IOSCO emphasized the importance of rate benchmarks to the financial system's "core functions" of pricing, allocating capital and risk. IOSCO stated its intent to reduce the chance of "financial instability and conduct" risks by raising awareness about the LIBOR transition and its importance.

IOSCO highlighted the significance of the Secured Overnight Financing Rate ("SOFR") and the preferred LIBOR substitute of U.S. regulators, and underscored key concerns in transitioning from the use of LIBOR to SOFR.

IOSCO noted the significant differences between LIBOR and SOFR, including that:

• USD LIBOR is a forward-looking rate with a term structure, while SOFR is an overnight rate;

• USD LIBOR contains a bank credit risk element and is based on unsecured credit risk, whereas SOFR is a nearly risk-free rate based on secured transactions; and

• USD LIBOR is derived from a small number of transactions, while SOFR is derived from a robust, active and liquid market.

IOSCO asked market participants to be mindful that in light of the disappearance of LIBOR as a going rate, for both new and outstanding contracts based on the rate, the inclusion of robust fallbacks should be a priority. IOSCO stated that risk will be best mitigated by transitioning away from LIBOR now (by using SOFR or another risk-free rate for new contracts).

While IOSCO urged the transition to SOFR, it also acknowledged the challenging tax and accounting issues presented by the transition. IOSCO reported that the Alternative Rates Reference Committee ("ARRC") "is of the view that currently, the SOFR derivatives market in the United States does not have enough depth to build a reliable, robust, transactions-based, forward-looking rate produced on a daily basis that would meet the criteria the ARRC set in choosing SOFR."