Regulators and the markets must ensure a rapid adoption of reference rates that will replace the London Interbank Offered Rate to avoid significant financial disruptions, Federal Reserve Bank of New York President William Dudley said May 24.
Dudley, speaking at a Bank of England event in London, noted that there is "no guarantee" the scandal-plagued LIBOR, will continue beyond 2021 — and even so, it has "serious flaws" that call for an alternative. The rate has for decades been used to price a wide array of financial contracts but came under fire in a rate-rigging scandal.
"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 place," Dudley said in prepared remarks. "Time is of the essence, and we must manage it well."
Last month, the New York Fed began publishing three reference rates aimed at serving as LIBOR alternatives, including its preferred Secured Overnight Financing Rate, or SOFR. The three rates have seen more volatility than LIBOR in its early days. Dudley also noted that the Financial Stability Board and International Organization of Securities Commissions have also done work on replacing LIBOR.
Dudley said he had confidence that the SOFR should be more resistant to manipulation and be "much more resilient during periods of financial stress," given that it is based off a Treasury repo market that "is likely to remain deep and active during such episodes."
Still, he said, there is a "long way to go" to ensure that any LIBOR replacement plans are implemented adequately.
Dudley called for action from market participants, calling the issue a "monumental and complicated effort" that will require unprecedented levels of cooperation. While financial crises are often sparked by a failure to spot major vulnerabilities, he said, the LIBOR discontinuation is one that the markets can anticipate.
"Therefore, a half-hearted effort or a failure to act would be inexcusable, especially after all we have learned from the experience of the financial crisis," he said. "Moving this core piece of the global financial system to a firm and durable foundation is essential and worth the cost."
