Introduction

Good morning.  I want to thank Tom Wipf, the ARRC, and the New York Fed for holding this series of symposia and for inviting me to share my thoughts and moderate an important discussion on our progress in the transition from LIBOR to SOFR specific to the derivatives markets.  Before I begin, please allow me to remind you that the views I express today are my own and do not represent the views of the Commodity Futures Trading Commission (CFTC or the Commission) or my fellow Commissioners.in

In early 2020, just before the global pandemic seized us, and when taking the train between D.C. and New York in a day was routine, I spoke at the ISDA/SIFMA AMG Benchmark Strategies Forum.[1]  My message for that day regarding LIBOR transition was about progress.  Quoting the ultimate Renaissance man Richard Buckminster Fuller, I stressed that a successful transition would only be achieved if we moved away from LIBOR altogether and adopted a new model that makes it obsolete.

At that point, we were just shy of two years away from the December 31, 2021 LIBOR “end-game,” and I was several years into my persistent engagement and dogged messaging in support of a successful transition through, among other things, sponsorship of the CFTC’s Market Risk Advisory Committee (MRAC) and establishment of its Interest Rate Benchmark Reform Subcommittee (the Benchmark Subcommittee).  The goal of the Benchmark Subcommittee, which is chaired by Tom (Wipf), has always been to complement the work of the ARRC by raising awareness and shedding light on potential challenges, identifying risks for financial markets and individual consumers, and providing solutions within the derivatives space as we barreled towards the endgame.

The previous ARRC SOFR symposium focused on loans and related markets. Andrew Bailey, Governor of the Bank of England, delivered salient remarks reminding us of the progress we have made and the challenges ahead as we make our final descent.[2]  I would like to take some time today to echo his remarks with a focus on our progress in the U.S. and some next steps, including today’s announcement by the Benchmark Subcommittee.

Habits

Before that, however, I want to take a moment to again emphasize that we need to end our caustic relationship with LIBOR.  While we talk about making a smooth transition to alternative risk-free-rates such as SOFR, what we really need to do to is cut the cord, make LIBOR obsolete, adopt a habit of “SOFR First.”

It has been over a decade since the first allegations of benchmark manipulation surfaced, and nine years since the CFTC began levying sanctions for LIBOR-related misconduct, which resulted in the collection of more than $3.3 billion.  In July 2017, when Governor Bailey, then the Chief Executive of the UK Financial Conduct Authority (FCA)—which regulates LIBOR—acknowledged that despite significant improvements to LIBOR, the goal of anchoring LIBOR submissions and rates to the greatest extent possible to actual transactions could not be achieved.[3]  The underlying market that LIBOR seeks to measure, the market for unsecured wholesale term lending to banks, was no longer active enough to anchor a benchmark.

By the numbers, around that time, the U.S. Federal Reserve estimated that the more than $200 trillion in outstanding volumes of USD LIBOR contracts were benchmarked to a rate generated by $1 billion per day.  For the three-month LIBOR, the standard reference rate in the derivatives markets, was less than US $1 billion of borrowing among the largest banks.  On many days, that number dropped below $100 million.[4]  As I looked forward in 2018 to what is now our present situation, I remarked that as a market regulator, it would be indefensible to allow hundreds of trillions of dollars of transactions to reference such a “zombie” LIBOR after several years of lead time.[5]

Last month, at the previous ARRC Symposium, Governor Bailey reminded us that this dire situation has not changed in the last four years.[6] 

The skewed proportionality that underlies LIBOR continues to raise serious concerns about market integrity, conduct risks, and greater financial stability risks.  Regulatory authorities have relied on broad market participation in the global cooperative and consultative efforts undertaken by ISDA (International Swaps and Derivatives Association) and committees like the ARRC, and have stood by ready to facilitate transition efforts by helping to avoid market dislocations.  However, we have often had to recognize that our policies, mandates, and missions do not always support requiring compulsory industry standard setting or change through regulation.  As has often been the hallmark of our derivatives markets, the CFTC’s role as the regulator is to support the industry-led process and apply and enforce existing standards under the Commodity Exchange Act and regulations.  As products and markets develop and evolve, along with the assets, benchmarks, and data points on which they are priced, regulators and lawmakers must ensure that the existing framework is adaptable or make necessary changes to support progress and ensure it remains transparent, equitable, and representative of what it is endeavors to achieve.

Domestic and global regulators are coordinating in their efforts and guidance, publishing timelines and transition plans, encouraging customer and client education, and most critically, standing firm that the most effective way to break from LIBOR is to cease entering new LIBOR contracts.

First, a Word on SOFR

Thanks to the ARRC, we have a new rate available to serve as a robust and reliable risk-free rate (RFR): the Secured Overnight Financing Rate or SOFR.  SOFR is a fully transactions-based rate with the widest coverage of any U.S. Treasury repurchase rate available.[7]  SOFR futures began trading on the Chicago Mercantile Exchange (CME) in May of 2018, with both one- and three-month contracts offered.  It offered clearing of over-the-counter (OTC) SOFR swaps that following October.[8]  LCH began clearing SOFR-based OTC overnight index and basis swaps that July, both well ahead of the ARRC’s phased transition plans.[9]  The Intercontinental Exchange, Inc. (ICE) launched trading in one- and three-month cash-settled SOFR futures in October 2018.[10]

Trading in the SOFR derivatives market has gradually expanded, with over $6 trillion in open interest in SOFR-based futures and swaps as of March.[11]  According to the ARRC’s most recent progress report, trading activity picked up noticeably in October 2020 when LCH and CME – the two major USD interest rate central counterparties or CCPs—successfully transitioned from the Effective Federal Funds Rate (EFFR) to SOFR for discounting and the calculation of Price Alignment Interest (PAI) on all outstanding cleared USD-denominated products.[12]  Of note, this transition was aided by the Benchmark Subcommittee’s sponsorship of a June 2020 virtual table-top exercise as a prelude to the PAI/discounting switch.[13]  The CCP discounting shift in October 2020 marked a fundamentally important event in the transition to robust alternative reference rates and the insights drawn from the tabletop exercise informed critical and fast approaching decision points.

Despite the overall rising growth in SOFR-based derivatives, it remains a small fraction of the total volume of cash and derivative products traded on LIBOR.

We all know that SOFR is different from LIBOR. The compounded SOFR used for SOFR derivatives is set in arrears at the end of the interest period while LIBOR is set in advance at the start of an interest period. Unlike LIBOR, SOFR (as it is fully collateralized) does not have a credit spread.  But given the market structure changes that fundamentally have brought LIBOR to its end, it would be irresponsible to wait for a new rate that replicates that blueprint for LIBOR.  We must move on with a rate that is based on sustained and robust transactions. Of note, SOFR is currently based on a daily average transaction volume of $900 billion.[14]

To avoid the conduct and stability risks that emerged when LIBOR became disconnected from actual activity, we must rely on a benchmark that is both representative of transactions and proportional to the depth and breadth of products that rely upon it.  SOFR demonstrates that fitness for the derivatives markets.

About that Progress

At this point, it is important to note that thanks to the incredibly hard work by ISDA and market participants, we now have robust fallback language for both cleared and uncleared interest rate derivatives contracts.  ISDA successfully launched the 2020 IBOR Fallbacks Protocol[15] to introduce robust fallback language for interest rate swaps.  The Protocol became effective on January 25, 2021.  The relevant CCPs simultaneously adopted the fallback language in their respective rule books for cleared swaps.[16]

Based on CFTC staff analysis of information from ISDA and data from swap data repositories, legal entities that account for close to 95% of gross notional outstanding – cleared + uncleared - in interest rate swaps (IRS) have adhered to the Protocol.  According to the ARRC, as of March 12^th, there were 13,540 adhering parties to the IBOR Fallbacks Protocol.[17]  There is a long tail of end-users with a small footprint in the swaps markets.  Our expectation is that many of them will either close their swap positions or negotiate appropriate fallback language bilaterally with their counterparties.  But not having a plan just because the firm has 1-2 open swaps is not an option.  To the extent there are large, active firms who have not yet adhered to the Protocol, relevant regulators and counterparties will be apt to take notice.  We’ll hear in a bit from ISDA’s CEO Scott O’Malia and others about adherence to the protocol.

Authorities had been highlighting the lack of robust fallback language in swaps contracts as a financial stability risk factor, for good reason.  Robust contractual language must be in place because we have known for over a decade that cessation of the reference rate was on the horizon.

2021: Time for Clean Break

ICE Benchmark Administrator, the administrator of LIBOR, working closely with its regulator, the UK FCA, announced in late 2020, that it would consult on its intention to cease the publication of the one week and two-month USD LIBOR settings immediately following the LIBOR publication on December 31, 2021, and the remaining USD LIBOR settings immediately following the LIBOR publication on June 30, 2023.[18]  Around the same time, recognizing the consumer protection, litigation, and reputational risks, the U.S. Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued an Interagency Statement on LIBOR Transition encouraging banks to cease entering into new contracts that reference USD LIBOR post December 2021.[19]  Mike Gibson, Director of the Division and Supervision and Regulation at the Federal Reserve Board will speak in a bit about the direction given to banks, and most important, the very narrow set of carve-outs for continued use of USD LIBOR post December 31, 2021.

On March 5, 2021, the FCA confirmed that all LIBOR settings will either cease to be provided by any administrator or no longer be representative: immediately after December 31, 2021, in the case of all sterling, euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar settings; and immediately after June 30, 2023, in the case of the remaining US dollar settings. [20]

From previous studies by CFTC staff, we observe that there is a CFTC registered swap dealer, mostly all banks, on one side of nearly all interest rate swaps.  Which means, in just over six months, as a customer, you will not be able to call your dealer, or request an electronic quote from your dealer, for a LIBOR swap, unless it is to hedge a transaction that was entered into before the end of 2021.  So how do we go from the low single-digit market share of SOFR, to what some expect, low single-digit market share of LIBOR?

SOFR First

This takes us to the announcement made earlier today by the MRAC’s Benchmark Subcommittee.[21]   Today’s announcement follows several years of collaboration between the CFTC, the Benchmark Subcommittee, and the ARRC.  CFTC staff has been working closely with the ARRC to provide regulatory relief to facilitate transition from the various IBORs to SOFR and other relevant alternative reference rates.  For example, in response to ARRC requests, in December 2019, three divisions of the CFTC issued staff no-action letters providing relief to market participants relating to the transition of swaps referencing IBORs.[22]  These letters and the staff no-action relief therein were updated in August 2020 to provide relief for additional types of swap amendments and refine relief previously provided based on feedback from market participants.[23]

The Benchmark Subcommittee has focused on finding ways to collaborate with market development initiatives of the ARRC, with a view to supplement and support these efforts.  The first major effort was around “plain English” disclosures that market participants could use, as they deem appropriate, with all clients and counterparties with whom they continued to transact derivatives referencing LIBOR and other IBORs.[24]  The disclosures informed clients and counterparties about the implications of using such products.  The second significant effort was the tabletop exercise with respect to the SOFR discounting switch by the CCPs I mentioned earlier.  The third, announced today, is to adopt a plan to shift [interdealer] USD derivatives trading in IRS, from LIBOR to SOFR, known as the “SOFR First” initiative.

To be clear, this is not Commission action and should be viewed as a best practice.  The SOFR First [Transition] Initiative (the Initiative) represents a prioritization of interdealer trading in SOFR over LIBOR.  Specifically, as part of the Initiative, the Benchmark Subcommittee recommends that interdealer brokers change USD linear swap trading conventions to SOFR on July 26, 2021.  After July 26, 2021, the interdealer market should replace trading of LIBOR linear swaps with trading of SOFR linear swaps.  LIBOR would be expected to be accessible as a basis to SOFR after this date.  However, screens for LIBOR linear swaps should remain visible for informational purposes only after this date.  In other words, the recommendation is that dealer to dealer trading in LIBOR linear swaps should cease at the end of July. All trading, outrights and basis swaps, would be around SOFR.  After October 22, 2021, the recommendation is that screens operated by platforms specializing in inter-dealer trading for LIBOR linear swaps should be turned off altogether.

Many of you have likely heard of the Sonia First effort in the UK, and we will be hearing from Edwin-Schooling Latter, Director of Markets and Wholesale Policy at the FCA, and others about it.  There is strong collaboration among authorities and as we learn from others’ experiences, the expectation is that in coming months, the Subcommittee will consider initiatives related to non-linear derivatives, exchange traded derivatives, and cross-currency swaps.

Given the most recent Financial Stability Board and International Organization of Securities Commissions (IOSCO) statements on LIBOR transition[25] which are consistent with and supportive of the interagency guidance from U.S. banking regulators that banks cease new LIBOR activities that I mentioned earlier,[26] the Benchmark Subcommittee believes it is prudent to change quoting conventions in the USD interest rate swaps market from USD LIBOR to SOFR in the near term.  This change in trading conventions is an important step to increase overall SOFR swap volumes and contribute to a smooth transition of liquidity towards SOFR.

Given the close economic and symbiotic relationship between futures and swaps markets, we should expect trading in SOFR futures to track the growth in SOFR swaps.  Tom (Wipf), will speak about why the group chose July and not a later date.  Simply put, given the sheer size of the USD IRS market, waiting till after summer, until Fall, will give us very little time to manage the transition.  There is broad consensus among all market participants, and not just the dealer banks, of the urgency to shift out of LIBOR.  Even today’s announcement is timed to ensure that market participants, the trading platforms, other service providers, have sufficient time to prepare for the July 26^th event.

Conclusion

I know that was quite a download to kick off this panel, so I will wrap it up quickly so we can dig more deeply into our progress to date and look further down the slope to our endgame.

I want to thank everyone at the ARRC, on the panel today, and out there watching for the collaboration, coordination, and communication that have already brought us this far in terms of progress.

[1] Rostin Behnam, Commissioner, CFTC, Remarks of Commissioner Rostin Behnam at the ISDA/SIFMA AMG Benchmark Strategies Forum 2020, New York, New York (Feb. 12, 2020), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam14.

[2] Andrew Bailey, Governor, Bank of England, Descending Safely: Life after LIBOR, Speech given at the Alternative Reference Rates Committee SOFR Symposium: The Final Year (May 11, 2021), https://www.bankofengland.co.uk/speech/2021/may/andrew-bailey-a-moderated-discussion-with-john-williams-president-of-ny-fed.

[3] Andrew Bailey, Chief Executive, Financial Conduct Authority, Speech at Bloomberg London: The Future of LIBOR (July 27, 2017), https://www.fca.org.uk/news/speeches/the-future-of-libor.

[4] Jerome H. Powell, Governor, Federal Reserve, Introductory Remarks at the Roundtable of the Alternative Reference Rates Committee, The Federal Reserve Bank of New York, New York (Nov. 2, 2017), https://www.federalreserve.gov/newsevents/speech/powell20171102a.htm.

[5] Rostin Behnam, Commissioner, CFTC, Our Collective Strength, Remarks of CFTC Commissioner Rostin Behnam at the 2018 ISDA Annual Japan Conference, Shangri-La Hotel, Tokyo (Oct. 25, 2018), https://www.cftc.gov/PressRoom/SpeechesTestimony/opabehnam11.

[6] Bailey, supra note 2.

[7] SOFR has been published daily by the Federal Reserve Bank of New York since April 3, 2018.  See, e.g. Federal Reserve Bank of New York, Reference Rates (2018), https://www.newyorkfed.org/medialibrary/media/research/advisory_panel/far/lieber_far_april2018.pdf?la=en.

[8] Press Release, CME Group, CME Group Announces First OTC SOFR Swaps Cleared (Oct. 9, 2018), https://www.cmegroup.com/media-room/press-releases/2018/10/09/cme_group_announcesfirstotcsofrswapscleared.html.

[9]Press Release, LCH, LCH Clears First SOFR Swaps (July 18, 2018), https://www.lch.com/resources/news/lch-clears-first-sofr-swaps.

[10] Press Release, ICE, Intercontinental Exchange Announces October 1 Launch of ICE one and Three Month SOFR Futures (Aug. 1, 2018), https://www.businesswire.com/news/home/20180801005430/en/Intercontinental-Exchange-Announces-October-1-Launch-of-ICE-One-and-Three-Month-SOFR-Futures.

[11] ARRC, Progress Report: The Transition from U.S. Dollar LIBOR at 6 (Mar. 2021), https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2021/USD-LIBOR-transition-progress-report-mar-21.pdf.

[12] Id.

[13] See Press Release Number 8171-20, CFTC, CFTC Market Risk Advisory Committee’s Interest Rate Benchmark Reform Subcommittee Holds Table Top Discussion and Revises Membership (June 2, 2020), https://www.cftc.gov/PressRoom/PressReleases/8171-20.

[14]Federal Reserve Bank of New York, Secured Overnight Financing Rate Data,  https://www.newyorkfed.org/markets/reference-rates/sofr (last visited June 3, 2021).

[15] The ISDA 2020 IBOR Fallbacks Protocol is available at http://assets.isda.org/media/3062e7b4/08268161-pdf/.

[16]See Letter from Christopher Bowen, Managing Director & Chief Regulatory Counsel, CME Group to Christopher Kirkpatrick, Office of the Secretariat, CFTC, Re: Regulation 40.5(a) Submission of Rules for Commission Review and Approval—Modifications to Interest Rate Swap Products to Implement ISDA IBOR Fallback Provisions, CME Submission No. 20-517 (Dec. 8, 2020), available at https://www.cftc.gov/sites/default/files/filings/orgrules/20/12/rule120920cmedco001.pdf.  See also Letter from Julian Oliver, Chief Compliance Officer, LCH Limited to Christopher Kirkpatrick, Office of the Secretariat, CFTC LCH Limited Self Certification: SwapClear Pre-cessation Triggers (Dec. 1, 2020), available at
https://www.lch.com/system/files/media_root/LCHLTD%20Self-Cert_pre%20cessation%20triggers%20final%20v1.pdf.

[17] ARRC, supra note 11 at 9.

[18] See ICE Benchmark Administration, ICE LIBOR Consultation on Potential Cessation (Dec. 2020), https://www.theice.com/publicdocs/ICE_LIBOR_Consultation_on_Potential_Cessation.pdf.

[19] Board of Governors of the Federal Reserve System, SR 20-27: Interagency Statement on LIBOR Transition (Nov. 30, 2020), https://www.federalreserve.gov/supervisionreg/srletters/SR2027.htm.  See also Board of Governors of the Federal Reserve System, SR 21-7: Assessing Supervised Institutions’ Plans to Transition Away from the Use of the LIBOR (Mar. 9, 2021), https://www.federalreserve.gov/supervisionreg/srletters/SR2107.htm.

[20] Press Release, Financial Conduct Authority, Announcements on the End of LIBOR (Mar. 5, 2021), https://www.fca.org.uk/news/press-releases/announcements-end-libor.

[21] Press Release Number, CFTC, CFTC’s Interest Rate Benchmark Reform Subcommittee Recommends Dates for Transitioning Interdealer Swap Market Trading Conventions to SOFR (June 8, 2021), https://www.cftc.gov/PressRoom/PressReleases/8394-21.

[22] More specifically, the Division of Swap Dealer and Intermediary Oversight issued CFTC Letter 19-26 providing relief to swap dealers from registration de minimis requirements, uncleared swap margin rules, business conduct requirements confirmation, documentation, and reconciliation requirements, and certain other eligibility requirements.  The Division of Market Oversight issued CFTC Letter 19-27 providing time-limited no-action relief from the trade execution requirement, while the Division of Clearing and Risk issued CFTC Letter 19-28 providing time limited relief from the swap clearing requirement and related exceptions and exemptions.  See Press Release Number 8096-19, CFTC, CFTC Provides Relief to Market Participants Transitioning Away from LIBOR (Dec. 18, 2019), https://www.cftc.gov/PressRoom/PressReleases/8096-19.

[23] See Press Release Number 82280-20, CFTC, CFTC Provides Additional Relief to Market Participants Transitioning from LIBOR (Aug. 31, 2020), https://www.cftc.gov/PressRoom/PressReleases/8228-20.

[24] See Interest Rate Benchmark Reform Subcommittee of the Market Risk Advisory Committee, Plain English Disclosures for New Derivatives Referencing LIBOR and other IBORs (Sept. 9, 2019), available at https://www.cftc.gov/PressRoom/Events/opaeventmrac090919.

[25]Press Release, Financial Stability Board, FSB issues statements to support a smooth transition away from LIBOR by end 2021 (June 2, 2021), https://www.fsb.org/2021/06/fsb-issues-statements-to-support-a-smooth-transition-away-from-libor-by-end-2021/; International Organization of Securities Commissions, Statement on Benchmarks Transition (June 2, 2021), https://www.iosco.org/library/pubdocs/pdf/IOSCOPD676.pdf.

[26] See supra note 19.