Toomey Warns Regulators Against Restricting SOFR Alternatives
Washington, D.C. – In his opening statement at today’s U.S. Senate Banking Committee hearing on the London Interbank Offered Rate (LIBOR) transition, Ranking Member Pat Toomey (R-Pa.) said that banks should retain the option to choose the qualified benchmark rate for new contracts and not be forced to adopt regulators’ preferred Secured Overnight Funding Rate (SOFR).
Senator Toomey also said any federal
legislation addressing tough legacy contracts must be very narrowly tailored,
not change the equities of the contracts, and not affect any new contracts.
Ranking Member Toomey’s remarks, as prepared
for delivery:
Thank you, Mr. Chairman.
The London Interbank Offered Rate – or LIBOR –
has long been the most widely used U.S. dollar-denominated benchmark interest
rate across all types of financial contracts. LIBOR is the rate at which large
banks report they can borrow from one another in the interbank market on a
short-term, unsecured basis.
At the end of 2020, over $223 trillion in
contracts referenced LIBOR, including loans, bonds, derivatives, and
securitizations. In 2013, the G20 launched a global review of interest rate
benchmarks after cases of misconduct in the reporting of LIBOR rates by a small
number of banks and the significant decline in interbank lending volume.
As the breadth and depth of interbank loan
market liquidity greatly diminished, it became clear that alternative rates
with greater volume and a larger number of market participants would be more
appropriate than LIBOR. In the United States, the Federal Reserve Board and the
New York Fed convened the Alternative Reference Rates Committee – or ARRC – to
identify an alternative to LIBOR.
In 2017, the ARRC identified the Secured
Overnight Financing Rate – or SOFR – as its recommended alternative to LIBOR.
SOFR measures the cost of overnight, or short-term, borrowing collateralized by
U.S. Treasury securities.
In 2020, daily volumes underlying SOFR were
consistently above $1 trillion. Last year, the Fed, FDIC, and OCC directed
banks to stop entering into new LIBOR contracts as soon as possible and no
later than the end of 2021.
Earlier this year, the administrator of LIBOR
announced that it will stop publishing all LIBOR settings by June 30, 2023.
Although most existing contracts referencing LIBOR will mature by that date, a
number of contracts will not, and lack fallback language to replace LIBOR with
a non-LIBOR rate. As a result, many have called for federal legislation to
address these so-called “tough legacy contracts.”
I agree banks should stop writing new LIBOR
contracts as soon as possible, and federal legislation is likely needed to
address tough legacy contracts. The unique and anomalous circumstances related
to the LIBOR transition require action by Congress to amend contracts between
private parties. Such congressional action should be a last resort.
As we consider this measure, any legislation
that addresses tough legacy contracts must be very narrowly tailored, not
change the equities of these contracts, and not affect any new contracts.
In July, the House Financial Services
Committee approved a bill that would replace LIBOR in tough legacy contracts
with a Fed-selected, SOFR-based benchmark. This bill takes a reasonable
approach, and the Senate should carefully review it. In doing so, we should
consider targeted amendments, such as ensuring that qualified non-SOFR
benchmark rates are not disfavored in future contracts.
While
it’s appropriate to mandate a SOFR-based index for this relatively small
universe of tough legacy contracts, for new contracts banks must have the option to choose among
qualified benchmark rates – including
credit-sensitive rates – as appropriate for their business models. Risk-free
rates like SOFR may work well for derivatives contracts and institutions active
in the Treasury repo market, but they may not be well-suited for loans or
certain community or regional banks.
The funding costs for such banks typically
increase relative to SOFR during periods of stress, which could create an
asset-liability mismatch if loans were required to reference SOFR. The Fed,
FDIC, and OCC have previously acknowledged this problem. They have said the use
of SOFR is voluntary and a bank may use “any reference rate for its loans that
the bank determines to be appropriate for its funding model and customer
needs.”
An even broader group of regulators said, in
the context of bank lending, that “supervisors will not criticize firms solely
for using a reference rate (or rates) other than SOFR.” However, I am concerned
this is exactly what Biden administration financial regulators are now seeking
to do.
Just last week, the Acting Comptroller of the
Currency said the OCC’s supervisory efforts will “initially focus on non-SOFR
rates.” This suggests that the OCC may apply heightened supervisory scrutiny to
non-SOFR rates. And last month, a senior New York Fed official said that banks
that use a non-SOFR rate must do “extra work” to ensure that the bank is
“demonstrably making a responsible decision.”
SEC Chair Gensler has been even more explicit.
On multiple occasions, he has criticized one particular credit-sensitive rate.
These statements raise serious concerns that regulators are pressing all banks
to use SOFR without any transparency or public input. If a bank wants to price
its loan off a rate it believes is a better reflection of its cost of funding
or customer needs than SOFR, regulators should not prohibit the bank from doing
so.
This pressure, however, pales in comparison to
the preferred approach of President Biden’s nominee to lead the OCC. Professor
Saule Omarova has written that widely used benchmark rates should either be
pre-approved by the government or, worse, subject to “utility-style
regulation.” In other words, the government – not the
market – would have a direct role in actually setting benchmark rates as it
deems appropriate.
This is just one example of the many radical
ideas that Professor Omarova has proposed that demonstrate a clear aversion for
democratic capitalism, and a clear preference for an administrative state where
decisions are made by technocrats who think they know more than the market.
Regulators should never disfavor qualified
rates, and banks should have the choice to use any rate that meets
well-established criteria for benchmark rates.
I hope to hear from today’s witnesses about
the transition from LIBOR, the potential for targeted federal legislation to
address tough legacy contracts, and ways to preserve benchmark rate choice.
###
Next Article Previous Article
