What Does the Fed Mean by ‘New’?

U.S. financial regulators have provided extra detail about just what should be defined as new LIBOR-related contracts, which they are pushing to bring to an end this year.

The Federal Reserve, along with four other federal bodies and various state overseers, released guidance on Wednesday that defines as “new” an agreement that creates additional London interbank offered rate (LIBOR) exposure for an institution or extends the term of an existing contract. The definition does not, however, include the drawdown of legally enforceable committed facilities that have not been fully tapped, leaving open the possibility of using existing revolvers.

And with just over two months until the year-end deadline to ditch LIBOR for “new” transactions, regulators are also urging institutions to cut ties even sooner than that. In their latest guidance, they suggested that any obligation entered into before December 31 should either use a reference rate other than LIBOR or have fallback language that provides for use of a “strong and clearly defined alternative.”

“Failure to adequately prepare for LIBOR’s discontinuance could undermine financial stability and institutions’ safety and soundness and create litigation, operational, and consumer protection risks,” regulators wrote, while also noting that supervisory focus and review will intensify as LIBOR’s end date nears.

While the end of this year will see a definitive end for one-week and two-month LIBOR benchmarks in dollar funding markets, quotes on other tenors will be available until June 2023 for legacy contracts. Regulators have been adamant, though, that these are not to be used for fresh contracts, and Wednesday’s statement is another reiteration of that.

In the meantime, there is increasing competition from new reference-rate providers seeking to carve out their own slice of the post-LIBOR landscape. The Fed’s long-preferred replacement, the Secured Overnight Financing Rate (SOFR), is at the center of this activity, but a slew of other reference rates—from Ameribor and the Bloomberg Short Term Bank Yield Index to ICE’s Bank Yield Index—are also garnering attention.

Other supervisory considerations outlined in the regulators’ latest guidance:

• When assessing the appropriateness of alternative reference rates, institutions should understand how their chosen rate is constructed and be aware of any fragilities associated with that rate and the markets that underlie it.
• Institutions should identify all contracts that reference LIBOR, lack adequate fallback language, and will mature after the relevant tenor ceases.
• Institutions should develop a transition plan for communicating with consumers, clients, and counterparties, as well as ensuring systems and operational capabilities will be ready for life after LIBOR.

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