In remarks at the Structured Finance Association Conference, Federal Reserve Board ("FRB") Vice Chair for Supervision Randal K. Quarles warned that the FRB will intensify its focus on financial institutions' transition planning as LIBOR cessation nears.
Mr. Quarles said that use of LIBOR after 2021 would "pose safety and soundness risks." He described recent supervisory efforts by banking regulators, in particular, the November 2020 letter, encouraging banks "to transition away from U.S. dollar (USD) LIBOR as soon as practicable." He said that the FRB is working with other regulators to provide further guidance on what qualifies as "new" use, but suggested this would "include any agreement that creates additional LIBOR exposure for a supervised institution or extends the term of an existing LIBOR contract."
Mr. Quarles also noted that data from Q2 of 2021 shows that large firms used alternative rates for less than one percent of floating rate corporate loans and eight percent of derivatives. He said that "lenders will have to pick up the pace, and our examiners expect to see supervised institutions accelerate their use of alternative rates." He also said, in response to requests for more time to evaluate alternative rates that, "[t]here is no more time, and banks will not find LIBOR available to use after year-end no matter how unhappy they may be with their options to replace it."
As to alternative rates, Mr. Quarles reiterated that banks may use the Secured Overnight Financing Rate ("SOFR") or another alternative rate that the bank deems appropriate for its funding model and customer needs. He added that banks using non-SOFR rates should make sure that they (i) are aware of the construction of the rate, and any associated "fragilities," and (ii) use strong fallback provisions.
Commentary
Vice Chair Quarles started this speech by establishing his literary bona fides, name-dropping Kant, Wodehouse, Eliot and Didion (including using a quote by the latter to sneak in a not-so-subtle dig at the conference venue - Las Vegas). While market participants may not agree with his choice of leisure reading, everything after that is important for users of LIBOR. Mr. Quarles made clear that the Fed is very serious about moving away from LIBOR and expects banks to act accordingly.
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