MIL-OSI USA: Remarks Before the Alternative Reference Rates Committee’s SOFR Symposium

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Source: Securities and Exchange Commission

Washington D.C.

Sept. 20, 2021

Thank you, Tom. As is customary, I’d like to note that my views are my own, and I’m not speaking on behalf of the Commission or SEC staff.

It’s good to be with the Alternative Reference Rates Committee to discuss the transition from the London Interbank Offered Rate (LIBOR). I’d like to thank the Committee, the New York Fed, and the Federal Reserve Board for putting this together.

As some of you may know, when the topic of LIBOR comes up, I sometimes find myself thinking about Hans Christian Andersen and Warren Buffett. Others of you might be wondering why I’d mention these two men — born 125 years and an ocean apart — in the context of LIBOR.

Well, as Hans Christian Andersen wrote in his famous folktale, “The Emperor’s New Clothes,” the emperor has no clothes.

And who is the emperor?

When I was at the Commodity Futures Trading Commission (CFTC), we thought of that emperor as LIBOR.[1]

You see, LIBOR had gotten to be so popular that it was embedded in hundreds of trillions of dollars of financial contracts around the world. Loans, derivatives, mortgages, and even supplier arrangements referenced LIBOR.

In reality, though, in good times there was very little lending of unsecured term loans between banks — in London, or anywhere else for that matter.

In stressed times, even that small market went away. Long before the 2008 crisis, it largely had dried up.

Banks simply were not making term loans to other banks without getting some collateral in return.

Because few transactions underpinned LIBOR, the people responsible for determining this benchmark tended to use their own judgment in setting it. That was not the only challenge. On top of that, LIBOR was easy to game.

The dedicated staff at the CFTC did a remarkable job uncovering many cases of manipulative conduct involving LIBOR at large banks.

Finally, somebody had pointed out that the emperor had no clothes.

Today, as we transition away from LIBOR, I want to be sure our replacement rates are appropriately clothed.

To that end, I have several concerns about one rate that a number of commercial banks are advocating as a replacement for LIBOR. This rate is called the Bloomberg Short-Term Bank Yield Index (BSBY).

I believe BSBY has many of the same flaws as LIBOR. Both benchmarks are based upon unsecured, term, bank-to-bank lending.

BSBY has the same inverted-pyramid problem as LIBOR. Like with LIBOR, we’re seeing a modest market, shouldering the weight of hundreds of trillions of dollars in transactions. When a benchmark is mismatched like that, there’s a heck of an economic incentive to manipulate it.

The markets underpinning BSBY not only are thin in good times; they virtually disappear in a crisis. Last spring, the primary commercial paper lending market evaporated for about five weeks during the initial stresses of the pandemic.

In the wake of the European debt crisis and the financial crisis, a group under the International Organization of Securities Commissions issued a report in 2013 on the hygiene of benchmarks like LIBOR.[2]

This IOSCO group, which I was honored to co-chair, found it was necessary to establish a benchmark that “reflects a credible market for an Interest measured by that Benchmark.”

The Financial Stability Board more recently echoed those views when it stated that “[b]enchmarks which are used extensively must be especially robust.”[3]

I don’t believe BSBY is, as FSB urged, “especially robust.” I don’t believe it meets IOSCO’s 2013 standards.

The sponsors of BSBY published a report in July. [4] This report, however, could not address the main concern that the rate is built off of too thin a market, that the emperor still has no clothes.

Term BSBY (1-, 3-, 6-, 12-month) is underpinned primarily by trades of commercial paper and certificates of deposit issued by 34 banks. Further, the median trading volume behind three-month BSBY is less than $10 billion per day.[5] Median trading volumes for 6- and 12-month BSBY are even lower.

That’s why I agree with the ARRC that the Secured Overnight Financing Rate (SOFR), which is based on a nearly trillion-dollar market,[6] is a preferable alternative rate.

Earlier, I said that the emperor is LIBOR. I’d hate if we replaced one clothes-less emperor with another based on the unsecured, term, bank-to-bank lending market that has dried up.

This brings me to Warren Buffett. He’s said, “You only find out who is swimming naked when the tide goes out.”[7] I worry that a crisis will reveal BSBY’s flaws all too clearly.

Let’s not wait for the tide to ebb to see the emperor still has no clothes.

Thank you.


[1] See Gary Gensler, “Libor, Naked and Exposed” (Aug. 7, 2012), available at https://www.nytimes.com/2012/08/07/opinion/libor-naked-and-exposed.html.

[2] See OICV-IOSCO, “Principles for Financial Benchmarks” (July 2013), available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf.

[3] See Financial Stability Board, “Interest rate benchmark reform” (June 2, 2021), available at https://www.fsb.org/wp-content/uploads/P020621-2.pdf.

[4] See BSBY: Additional analysis and key facts (July 1, 2021), available at https://assets.bbhub.io/professional/sites/27/Bloomberg_BSBY_Report_070121-1.pdf.

[5] See Bloomberg Professional Services, “White Paper: Introducing the Bloomberg Short-Term Bank Yield Index (BSBY)” (Dec. 18, 2020), available at https://www.bloomberg.com/professional/introducing-the-bloomberg-short-term-bank-yield-index-bsby/.

[6] See Federal Reserve Bank of New York, “Secured Overnight Financing Rate Data,” available at https://www.newyorkfed.org/markets/reference-rates/sofr.

[7] See Money.com, “Swimming Naked When the Tide Goes Out” (April 2, 2009), available at https://money.com/swimming-naked-when-the-tide-goes-out/.

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