With a little luck, financial markets may get a better sense of how soon they'll be transitioning to the potential U.S. candidate to replace Libor.
On Tuesday, a Federal Reserve-sponsored group that has been working on an alternative is slated to discuss the timing of the release of the measure. The new rate, which the New York Fed plans to begin publishing daily sometime in the first half of 2018 in cooperation with the Treasury Department's Office of Financial Research, eventually could be the benchmark for pricing some $350 trillion of U.S. derivatives, student loans, home mortgages and many other types of credit.
The meeting of the Alternative Reference Rates Committee follows comments last week by the U.K. Financial Conduct Authority that it intends to stop compelling banks to submit London interbank offered rates by the end of 2021, igniting concerns global regulators may have to speed up their implementation timelines for new alternative benchmarks. According to an interim report, ARRC said it considered and rejected plans that call for a "quicker and more disruptive transition" and recognized that its proposed recommendations "could take several years to accomplish."
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"The FCA announcement is clearly going to accelerate the process," said Lou Crandall, chief economist at Wrightson ICAP. "They're not announcing a hard stop here. What they're doing is giving the market 4 ½ to recognize that they have a very significant operational risk ahead of them. It's a lot of pressure."
The group is meeting for the first time since it recommended replacing Libor with a new, broad Treasury repurchase agreement, or repo, rate. After it announced the decision June 22, the committee said it would be refining its proposed transition plans and develop implementation options for its recommended rate in consultation with members of the group, with the intention of publishing a final report later this year.
The unpublished Broad Treasury Financing Rate, or BTFR, is based on the cost of overnight loans that use U.S. government debt as collateral, about $660 billion in daily transactions.
ARRC first convened in November 2014 to identify a set of alternative reference rates that were more firmly based on market transactions. In June, the committee decided between the BTFR, or the New York Fed's overnight bank funding rate, or OBFR, a volume-weighted median of overnight fed funds and eurodollar transactions of U.S.-based bank offices.
The U.S. has picked a secured rate, collateralized by Treasuries, whereas the U.K., Europe and Japan have chosen or are veering toward unsecured, uncollateralized rates. A swaps-industry working group in the U.K. had proposed replacing Libor with the Sterling Over Night Index Average, or Sonia. Many in Europe already consider Eonia, the Euro Overnight Index Average, to be a viable alternative rate to Euribor. Japan identified the uncollateralized overnight call rate, known as Tonar, calculated and published by the Bank of Japan as the JPY risk-free rate.
Even though the FCA has given market participants and regulators a four-and-a-half-year notice, there are still significant risks. With a new benchmark come questions about hedging effectiveness, as well as how to shift the $350 trillion derivatives market away from Libor.
"This is a massive, massive can of worms that could get opened in a huge change," said Michael Cloherty, head of U.S. interest-rate strategy at RBC Capital Markets. "ARRC was all about a long transition, continuing to trade Libor derivatives well into the future to avoid an extremely ugly transition. The FCA slightly raises the risk of a big bang."
Bloomberg News
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