For release at
8:30 a.m. EDT
November 2, 2017
Introductory Remarks
(via prerecorded video)
by
Jerome H. Powell
Member
Board of Governors of the Federal Reserve System
At the
Roundtable of the Alternative Reference Rates Committee
The Federal Reserve Bank of New York
New York, New York
November 2, 2017
Good morning. I am sorry that I am not able to be with you today at the FRBNY for this
important meeting. I thought that I would begin by discussing the LIBOR related events that
have brought us here, and then talk about the way forward.
LIBOR gained negative public attention when reports began to surface during the
financial crisis that employees at some banks had attempted to manipulate the rate by altering the
quotes they submitted for use in the calculation of LIBOR. A number of agencies, including the
Commodity Futures Trading Commission (CFTC), the Department of Justice, and the U.K.
Financial Conduct Authority (FCA), took the lead in investigating and prosecuting the cases of
LIBOR manipulation that were uncovered. The Federal Reserve also joined in international
efforts to strengthen LIBOR. Among other things, we joined the ICE Benchmark
Administration's (IBA's) LIBOR Oversight Committee as an observer, and we also worked
intensively with international authorities and IBA in developing and encouraging the reforms set
out in IBA's Roadmap for LIBOR.
But at the same time, as we and other authorities collected data on the transactions
underlying banks' submissions to LIBOR, we began to see that those transactions were relatively
few and far between. As a result, many began to question whether LIBOR could be truly and
permanently fixed. To be sure, much has been done to address the cases of attempted
manipulation, and LIBOR has much stronger governance in place than it did before the crisis.
The question instead was whether there were enough actual LIBOR transactions to form a stable
basis for this critical rate.
Since many of the pressures around LIBOR stem from the low level of underlying
transactions, let me share some data regarding activity in U.S. dollar wholesale funding markets.
Today, there are 17 banks that submit quotes in support of dollar LIBOR. Some have suggested
requiring more banks to submit LIBOR data, but doing so would not materially improve the
situation. The panels in Figure 1 show the distribution of daily aggregate wholesale dollar
funding volumes for the 30 global systemically important banks (or GSIBs). The data here
include all of the Eurodollar, federal funds, CD, and commercial paper transactions that the
Federal Reserve has access to--the most complete picture of U.S. dollar unsecured funding that I
am aware of. For one-month funding, shown in the top panel, the median daily volume of
transactions by these banks since money-market reforms took effect last year was just over $1
billion. For three-month funding (the middle panel), the most heavily referenced LIBOR tenor,
the median is less than $1 billion per day. On some days we see less than $100 million. If we
compare this to the more than $100 trillion in outstanding volumes of U.S. dollar LIBOR
contracts, it should be clear that the activity in this market is miniscule compared to the size of
the contracts written on it.
In our view, it would not be feasible to produce a robust, transaction-based rate
constructed from the activity in wholesale unsecured funding markets. A transactions-based rate
from this market would be fairly easy to manipulate given such a thin level of activity, and the
rate itself would likely be quite volatile. Thus, LIBOR seems consigned to rely primarily on
some form of expert judgment rather than direct transactions.
As we discussed these issues with the officials in the United Kingdom who oversee and
regulate LIBOR, we also became aware that they were receiving a steady stream of requests, and
sometimes demands, from banks seeking to leave the LIBOR panels. The use of expert
judgment in submissions allows LIBOR to be published every day, but many banks are now
understandably uncomfortable with being asked to provide judgment about something that they
do very little of. In his July speech, Andrew Bailey discussed the efforts of the FCA to keep
these banks on the panels. Market participants should understand that the official sector has
done everything it can to stabilize and strengthen LIBOR. Without the intervention of U.K.
authorities, LIBOR would be in a weaker state today.
But that balancing act has grown increasingly difficult. As time has passed, some banks
have grown more resistant to public-sector entreaties to remain on the panels. As you know, one
bank left the U.S. dollar panel last year. At the same time, we have had to confront the fact that,
if banks could not be persuaded to voluntarily remain on panels, then the legal powers to compel
them to do so were limited. Under European Union benchmark regulations, which LIBOR will
soon be subject to, authorities can only compel submissions to a critical benchmark for a period
of two years. Given this time limit, brokering a voluntary agreement with the submitting banks
to stay on for a longer period was the last, best choice that authorities had available to guarantee
some further period of stability for LIBOR. CFTC Chairman Chris Giancarlo and I have
publicly supported the FCA's efforts to secure an agreement with the submitting banks to stay on
through the end of 2021, and we have encouraged the U.S. banks that submit to LIBOR to
cooperate with FCA's effort.
Of course, LIBOR may remain viable well past 2021, but we do not think that market
participants can safely assume that it will. Users of LIBOR must now take in to account the risk
that it may not always be published. While the public's understanding of this risk has increased
significantly since Andrew Bailey's speech, the official sector has been concerned about it for
some years, as reflected for example in our public comments and in the annual reports of the
Financial Stability Oversight Council. Given our understanding of the risks to LIBOR, the
Federal Reserve convened the Alternative Reference Rates Committee (or ARRC) in 2014 in
cooperation with the Treasury Department and CFTC. Consistent with recommendations from
the Financial Stability Board (FSB), we charged the ARRC with identifying a robust alternative
to U.S. dollar LIBOR and with developing a plan to encourage its use in some derivatives and
other transactions as appropriate.
The ARRC has accomplished the things that we asked of it. I want to thank the members
for their work and also to extend my special thanks to Sandie O'Connor as the chair of the
ARRC. Sandie will discuss the ARRC's work shortly, but I'll make a few points.
First, I'd note that, like most market participants, the ARRC members initially had a
difficult time conceiving of any kind of transition from LIBOR. As is the case for all of you, a
transition will be a complicated task for the broker-dealers and other members of the ARRC, and
will involve significant costs. Over time, however, I think the ARRC members have developed a
greater understanding of the risks to LIBOR and now see that, despite those complications and
costs, a transition may prove necessary. I also think that, having had time to consider the
transition plans that Sandie will talk about, ARRC members have become more comfortable with
the idea that a transition is feasible, even if the necessity of achieving it is regrettable.
Second, it is clear that any rate the ARRC selected as a potential alternative needed to be
highly robust. There would be no point in selecting a rate that might find itself quickly in the
same kinds of conditions that LIBOR is in now. In our view, the ARRC has chosen the most
robust rate available. In general, only overnight unsecured or secured funding markets appeared
to have enough underlying transactions to produce a robust rate. The overnight Treasury repo
market is the largest and most active market in any tenor of U.S. rates markets. Figure 2
illustrates the point: the transactions underlying the Secured Overnight Financing Rate (SOFR),
at about $700 billion per day or more, are much larger than the volumes in overnight unsecured
markets, even much larger than estimates of the volume in Treasury bills, and they dwarf the
volumes in other term markets. The alternative reference rate needs to be able to stand the
weight of having trillions of dollars written on it, and the ARRC has definitely met this standard
in choosing SOFR.
Third, we charged the ARRC with devising plans for a voluntary transition that
encouraged the use of their recommended rate where appropriate. We have never told anyone
that they cannot use LIBOR. The ARRC did consider whether other cash products could move
from LIBOR to the rates it evaluated, but their paced transition plan has focused on derivatives
because that is where the largest gross exposures to LIBOR are, and because it may be easier for
many derivatives transactions to move away from LIBOR to a new rate.
Now, however, market participants have realized that they may need to more seriously
consider transitioning other products away from LIBOR, and the ARRC has expanded its work
to help ensure that this can be done in a coordinated way that avoids unnecessary disruptions.
Sandie will discuss plans to eventually create a term reference rate, which may help to smooth
any transition. That term reference rate would have to be built by first developing futures and
OIS markets that reference SOFR. It will likely never be as robust as SOFR itself, and so
derivatives transactions will almost certainly need to be based on the overnight rate, but a term
reference rate could conceivably be used in some loan or other contracts that currently reference
LIBOR.
All of the work that we will talk about today will help, but we have to acknowledge that
the transition will be complicated. Unfortunately, as I have discussed, we cannot guarantee that
it won't be necessary. The most complicated aspects involve the legacy contracts that reference
LIBOR, many of which do not have strong language in place if LIBOR were to stop publication.
The FSB has been working with the International Swaps and Derivatives Association (or ISDA)
to devise better language for derivatives, and ISDA's Scott O'Malia and Katherine Tew Darras
will discuss that work later this morning. As people now consider the risks around LIBOR for
other types of contracts, they will need to go through their documentation to understand what the
fallback language is and how it can be improved. We will also discuss those issues today. This
is important work, both for the parties to these contracts and for our financial stability. While
there may be no perfect contract language or fallback, good risk management requires that we
work together to find language and fallbacks that are robust and that limit unintended valuation
changes.
So, while much work has been done, there is more still to do. I have been heartened in
seeing that many market participants are already confronting these issues. For some, Andrew
Bailey's speech was a difficult wake-up call. But the efforts we have undertaken with the ARRC
show what is possible when the official sector works collectively with market participants. If
market participants are willing to continue to work together, then we can safely achieve the
transitions needed to create a better and more robust system that will help to ensure our ongoing
financial stability.
Figure 1: Distribution of Daily Unsecured Funding Volumes of the G-SIB Firms
Post Money-Market Reform
Percent of days with
One-Month Funding Volumes
observed volume
12%
Median
10%
8%
6%
4%
2%
0%
$100 $500 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5
million million billion billion billion billion billion billion billion billion
Percent of days with
Three-Month Funding Volumes
observed volume
14%
Median
12%
10%
8%
6%
4%
2%
0%
$100 $500 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5
million million billion billion billion billion billion billion billion billion
Percent of days with
Six-Month Funding Volumes
observed volume
18%
Median
15%
12%
9%
6%
3%
0%
$100 $500 $1.0 $1.5 $2.0 $2.5 $3.0 $3.5 $4.0 $4.5
million million billion billion billion billion billion billion billion billion
Source: FR2420 and DTCC. Daily volumes aggregated across all available fed funds, Eurodollar, certificates of deposit, and
unsecured commercial paper transactions of the 30 global systemically important banks with tenors between 25 and 35
calendar days (for one month), 80 and 100 calendar days (three month), or 150 and 210 calendar days (six month) over the
period October 15, 2016 to June 30, 2017.
Figure 2: Daily Volumes in Selected U.S. Money Markets
Daily Volumes in U.S. Money Markets
Billions USD
800
$754 billion
700
600
500
400
300
$197 billion
200
100
$79 billion
Est. $13 billion
$1.1 billion
$343 million $132 million
0
Secured Overnight Bank Effective 3-month T-bills 3-month GSIB 3-month AA 3-month A2/P2
Overnight Funding Rate Federal Funds wholesale nonfinancial CP nonfinancial CP
Financing Rate Rate funding
(SOFR)
Average volumes over 2017H1, with the exception of 3-month T-bills, which are preliminary estimates from available FINRA
Trade Reporting and Compliance Engine (TRACE) data over August and September 2017. 3-month volumes are based on all
transactions with remaining maturities between 80 and 100 calendar days or 41-80 business days. Source: Federal Reserve
Bank of New York; Finance Industry Regulatory Authority; DTCC Solutions LLC, an affiliate of the Depository Trust & Clearing
Corporation; and the Board of Governors of the Federal Reserve.