Jerome H Powell: Introductory comments - Roundtable on the Interim
Report of the Alternative Reference Rates Committee
Introductory comments by Mr Jerome H Powell, Member of the Board of Governors of the
Federal Reserve System, at the Roundtable on the Interim Report of the Alternative
Reference Rates Committee, sponsored by the Federal Reserve Board and the Federal
Reserve Bank of New York, New York City, 21 June 2016.
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I want to thank you all for coming today, and I also want to thank the Alternative Reference
Rates Committee (ARRC) for all its work in developing its interim report. This report marks a
new stage in reference rate reform.1 Reference benchmarks are a key part of the financial
infrastructure. About $300 trillion dollars in contracts reference LIBOR alone. But
benchmarks were not given much consideration prior to the recent scandals involving
attempts to manipulate them. Since then, the official sector has thought seriously about
financial benchmarks, conducting a number of investigations into charges of manipulation,
publishing the International Organization of Securities Commission's (IOSCO) Principles for
Financial Benchmarks and, through the Financial Stability Board (FSB), sponsoring major
reform efforts of both interest rate and foreign exchange benchmarks.2 The institutions
represented on the ARRC have also had to think seriously about these issues as they have
developed this interim report. Now, we need end users to begin to think more seriously about
how they use benchmarks and the risks they are taking on by relying so heavily on a
reference rate - in this case U.S. dollar LIBOR - that is less resilient than it needs to be.
In saying this, I want to make it clear that LIBOR has been significantly improved. ICE
Benchmark Administration is in the process of making important changes to its methodology,
and submissions to LIBOR are now regulated by the United Kingdom's Financial Conduct
Authority. However, the term money market borrowing by banks that underlies U.S. dollar
LIBOR has experienced a secular decline. As a result, the majority of U.S. dollar LIBOR
submissions must still rely on expert judgement, and even those submissions that are
transaction-based may be based on relatively few actual trades. This calls into question
whether LIBOR can ultimately satisfy IOSCO Principle 7 regarding data sufficiency, which
requires that a benchmark be based on an active market. That Principle is a particularly
important one, as it is difficult to ask banks to submit rates at which they believe they could
borrow on a daily basis if they do not actually borrow very often.
That basic fact poses the risk that LIBOR could eventually be forced to stop publication
entirely. Ongoing regulatory reforms and changing market structures raise questions about
whether the transactions underlying LIBOR will become even scarcer in the future,
particularly in periods of stress, and banks might feel little incentive to contribute to U.S.
dollar LIBOR panels if transactions become less frequent. Market participants are not used to
thinking about this possibility, but benchmarks sometimes come to a halt. The sudden
cessation of a benchmark as heavily used as LIBOR would present significant systemic risks.
It could entail substantial losses and would create substantial uncertainty, potential legal
challenges, and payments disruptions for the market participants that have relied on LIBOR.
These disruptions would be even greater if there were no viable alternative to U.S. dollar
LIBOR that market participants could quickly move to.
These concerns led the FSB and Financial Stability Oversight Council to call for the
promotion of alternatives to LIBOR, and led the Federal Reserve to convene the ARRC in
cooperation with the U.S. Treasury Department, U.S. Commodity Futures Trading
Commission, and Office of Financial Research. LIBOR is currently the dominant reference
rate in the market because of its liquidity. We are not under any illusions that moving a
significant portion of trading to an alternative rate will be simple or easy. But I believe the
ARRC has provided a workable and credible plan for creating liquidity in a new rate and
beginning the process of moving trading to it.
We need input from end users and others to finalize the ARRC's plans, and I look forward to
hearing the views of those in attendance. Successful implementation will require a
coordinated effort from a broad set of market participants. This effort will certainly entail
costs, but continued reliance on U.S. dollar LIBOR on the current scale could entail much
higher costs if unsecured short-term borrowing declines further and submitting banks choose
to leave the LIBOR panels, especially if there were no viable alternative rate. Simply put, this
effort is something that needs to happen, and if the ARRC members, the official sector, and
end users and other market participants all jointly coordinate in finalizing these plans, then a
successful transition can be made with the least disruption to the market, leaving everyone in
a better place.