IGTA Journal - Summer 2018

and are trusted independent parties. In my view, central banks also ultimately “own” the financial stability risks that are present when key reference rates are flawed. Better to recognize this responsibility and move proactively to mitigate such risks than to step aside and hope that someone else will take up the mantle of reform. The Federal Reserve has designed these benchmarks to be compliant with IOSCO principles, with regular review by oversight bodies and comprehensive ethics and conflict-of-interest policies for staff . Best practice also dictates that administrators periodically review the rates they produce to assess whether changes in the underlying markets require changes in how those rates are administered. We have dedicated significant resources to these efforts, and are committed to the continued production of rates so that market participants can have confidence about their long-term viability. For these reasons, the Federal Reserve concurs with the ARRC that SOFR represents a compelling alternative to U.S.-dollar LIBOR—particularly for most derivatives transactions, where a near risk-free rate is more appropriate than a rate that incorporates a bank credit risk premium. Nevertheless, market adoption of SOFR faces its own challenges, such as the development of sufficient liquidity in derivatives that reference SOFR, and the establishment of a term reference rate, which I will discuss in a moment. These elements will have to be built over time. The ARRC’s Paced Transition Plan lays out a timeline for the milestones that must reached over the coming quarters and years for a successful transition . I am confident that the ARRC will succeed, but it will take considerable attention and effort. Progress is already evident. The Chicago Mercantile Exchange began offering SOFR futures contracts earlier this month, and trading activity has gotten off to a good start. Development of SOFR derivatives, in turn, will support the creation of a term reference rate. Although the ARRC’s transition plan anticipates that this will be completed by the end of 2021, it would be better for this to occur more expeditiously. The good news is that is broadly appreciated. In this vein, the Committee’s second report discussed some of the term rate alternatives, and development of proposals for a term reference rate was recently added to its mandate. In this regard, I would also encourage market participants, academics, and other interested parties to contribute to the effort to develop a term reference rate. Another key area of focus—further motivated by Andrew’s warning—is the development of fallback contract language in the event that LIBOR ceases to be published. The absence of such language creates the potential for large-scale disorder in global financial markets should LIBOR go away. Put simply, this is an unacceptable risk. The International Swap Dealers Association (ISDA) has been working on this issue for the derivatives market and is expected to issue a consultative document soon that should prove instrumental in making further progress. The ARRC has also been coordinating a similar effort across cash products of all types. The goal is to achieve consensus on a consistent approach across markets whenever feasible. Looking Ahead As I have noted previously, LIBOR continues to have significant shortcomings despite strengthened governance in recent years, and uncertainty about its future will only grow over time. This uncertainty reflects the limited liquidity underlying LIBOR and the corresponding legal risks I discussed earlier. But, I am also skeptical about whether LIBOR can ever be adequately transaction-based. As Andrew highlighted, there is no guarantee that LIBOR will continue to exist beyond December 2021. In my view, LIBOR is likely to go away—and it should, because it is not supported by a sufficiently robust regime. The LIBOR countdown clock should provide an impetus for action, but it should also make market participants and regulators increasingly nervous as we approach the deadline—especially if longer-term solutions are not in train or in 20 21 4 / 6 BIS central bankers' speeches IGTA eJournal | Summer 2018 | 49