FRB Governor Powell Discusses Reforming U.S. Dollar LIBOR (with Lofchie Comment)

Governor Jerome H. Powell of the Board of Governors of the Federal Reserve System ("FRB") talked about reforming LIBOR. In remarks before the Money Marketeers of New York University, Powell focused on U.S. Dollar LIBOR.

According to Governor Powell, U.S. dollar LIBOR is currently produced by a panel of 18 banks that estimate daily the rate at which they could borrow at several different maturities, ranging from overnight to a year. These banks send the estimates to the ICE Benchmark Administration ("IBA"), which discards the highest and lowest quartiles at each maturity and publishes an average of the remaining submission as the U.S. dollar LIBOR rate for that day.

Governor Powell highlighted a number of problems with using LIBOR as the global reference rate. He stated that while dollar LIBOR is the reference rate used in most U.S. interest rate swaps, futures contracts and floating-rate mortgages, many commercial loans, and structured products, such as mortgage- and asset-backed securities, it is not ideally suited for some of these purposes. Additionally, Governor Powell explained that due to the decline of unsecured interbank borrowing and scarcity of actual transactions that banks can use to estimate their daily submission to LIBOR, the foundation of the reference rate has been weakened.

To address these issues, Governor Powell cited two ideas identified in a Financial Stability Board Report (July 2014) on reforming interest rate benchmarks: (i) redefine LIBOR to include a broader range of transaction types, and (ii) promote robust alternatives to the dollar LIBOR that better reflect the secured nature of many of today's financial market transactions. According to Governor Powell, the FRB intends to work closely with the IBA, the Financial Conduct Authority, and market participants to investigate these reforms.

Lofchie Comment: The Financial Stability Board Report provides a number of country-specific discussions, including a discussion of U.S. LIBOR that begins on page 38. One of the more interesting aspects of the discussion is creating one base rate for secured borrowings (such as repos and collateralized derivatives exposures) and another rate for unsecured borrowings. Both borrowers and lenders should read the relevant sections of the report as it applies to them. For financial institutions that are entering into long-term credit arrangements tied to LIBOR, it is probably worthwhile to consider whether it makes sense to provide for the substitution of an alternative base rate if continued reliance on LIBOR is discouraged by the regulators or if confidence in the measure continues to erode.

See: Governor Powell's Speech.
See also: LIBOR/Indices Specialty Page (available to Cabinet subscribers only).