New York lawmakers passed legislation that could help smooth the transition of a large portion of $1.9 trillion in financial contracts from the London Interbank Offered Rate (LIBOR) to a new reference rate approved by the Federal Reserve.
The bill, which now goes to Governor Andrew Cuomo for signature, will switch LIBOR-linked contracts lacking clear fallback language to the Fed-endorsed Secured Overnight Financing Rate (SOFR) when LIBOR expires in June 2023, reducing litigation risk.
Tom Wipf, chairman of the Alternative Reference Rate Committee (ARRC) of private-market participants convened by the Fed, said the legislation “marks a major milestone in the transition away from LIBOR” and “will address a key risk” in the move to SOFR.
The Fed, and other regulators in the U.S., U.K. and other countries, have urged companies to switch to alternative rates from LIBOR, the reference rate for trillions of dollars in mortgages, business loans, derivatives and other financial contracts worldwide.
Fed Vice Chair Randal Quarles on March 22 flagged “safety and soundness concerns” and called for a halt in the use of LIBOR in new financial contracts.
Bank examiners should consider taking supervisory action against institutions that “are not making adequate progress in transitioning away from LIBOR,” he said.
Quarles expressed concern that, despite repeated warnings from regulators since 2017, use of U.S. dollar LIBOR has increased to nearly $223 trillion in outstanding financial contracts from about $200 trillion in 2018.
Many of the LIBOR-linked contracts lacking clear fallback language were written on Wall Street, according to the ARRC. The New York law will apply to those contracts and could serve as a model for federal legislation. Quarles described legislation in New York and at the federal level as "vital."
The New York “legislation will be crucial in minimizing legal uncertainty and adverse economic impacts associated with the transition — providing greater certainty to investors, businesses and consumers,” the ARRC said.
Fed Chairman Jerome Powell told the House Financial Services Committee last month that federal legislation is needed to clarify the transition from LIBOR for contracts lacking clear fallbacks.
A flawed LIBOR transition could jeopardize market stability, the Financial Stability Oversight Council of U.S. regulators said in its annual report.
The U.K. Financial Conduct Authority, LIBOR's administrator, announced on March 5 it will delay to mid-2023 the sunsetting of some of the most commonly used tenors of the benchmark rate.
The final fixings for most LIBOR rates — including 1-week and 2-month U.S. dollar LIBOR — will be made on Dec. 31, 2021, but other U.S. dollar tenors may continue until June 30, 2023.
SOFR adoption has accelerated over the past several months but is far from eclipsing LIBOR.
SOFR is based on overnight repurchase agreements secured by Treasuries and, unlike LIBOR, does not let treasurers make forward-looking rate calculations. LIBOR is based on London banks' estimates of what they would be charged when borrowing from other banks.