[Senate Hearing 117-357]
[From the U.S. Government Publishing Office]
S. Hrg. 117-357
THE LIBOR TRANSITION: PROTECTING CONSUMERS AND INVESTORS
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HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING HOW THE FINANCIAL SYSTEM CAN MOVE ON FROM THE LIBOR SYSTEM
__________
NOVEMBER 2, 2021
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov/
__________
U.S. GOVERNMENT PUBLISHING OFFICE
48-451 PDF WASHINGTON : 2023
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
SHERROD BROWN, Ohio, Chairman
JACK REED, Rhode Island PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey RICHARD C. SHELBY, Alabama
JON TESTER, Montana MIKE CRAPO, Idaho
MARK R. WARNER, Virginia TIM SCOTT, South Carolina
ELIZABETH WARREN, Massachusetts MIKE ROUNDS, South Dakota
CHRIS VAN HOLLEN, Maryland THOM TILLIS, North Carolina
CATHERINE CORTEZ MASTO, Nevada JOHN KENNEDY, Louisiana
TINA SMITH, Minnesota BILL HAGERTY, Tennessee
KYRSTEN SINEMA, Arizona CYNTHIA LUMMIS, Wyoming
JON OSSOFF, Georgia JERRY MORAN, Kansas
RAPHAEL WARNOCK, Georgia KEVIN CRAMER, North Dakota
STEVE DAINES, Montana
Laura Swanson, Staff Director
Brad Grantz, Republican Staff Director
Elisha Tuku, Chief Counsel
Dan Sullivan, Republican Chief Counsel
Cameron Ricker, Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
(ii)
C O N T E N T S
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TUESDAY, NOVEMBER 2, 2021
Page
Opening statement of Chairman Brown.............................. 1
Prepared statement....................................... 26
Opening statements, comments, or prepared statements of:
Senator Toomey............................................... 3
Prepared statement....................................... 27
WITNESSES
Thomas Wipf, Chair of The Alternative Reference Rate Committee
(ARRC) and Managing Director, Morgan Stanley................... 5
Prepared statement........................................... 28
Responses to written questions of:
Senator Warren........................................... 43
Andrew Pizor, Staff Attorney, National Consumer Law Center....... 7
Prepared statement........................................... 30
Responses to written questions of:
Senator Warren........................................... 44
J. Christopher Giancarlo, Senior Counsel, Willkie Farr &
Gallagher LLP, and Former Chairman, U.S. Commodity Futures
Trading Commission............................................. 8
Prepared statement........................................... 34
Michael Bright, Chief Executive Officer, Structured Finance
Association.................................................... 10
Prepared statement........................................... 38
Additional Material Supplied for the Record
ICBA letter...................................................... 46
LIBOR letter..................................................... 47
CAMAC letter..................................................... 49
NAFCU letter..................................................... 50
Brookline Bank letter............................................ 51
Statement submitted by SIFMA..................................... 52
(iii)
THE LIBOR TRANSITION: PROTECTING CONSUMERS AND INVESTORS
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TUESDAY, NOVEMBER 2, 2021
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10 a.m., via Webex and in room 538,
Dirksen Senate Office Building, Hon. Sherrod Brown, Chairman of
the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN SHERROD BROWN
Chairman Brown. The Committee on Banking, Housing, and
Urban Affairs will come to order. Welcome to the witnesses, who
I will introduce in a moment.
This hearing is in a hybrid format. Members have the option
to appear either in person or virtually. I think all my
colleagues know the rules of that and the procedures. Our
speaking order will be as usual, that is by seniority of the
Members who have checked in before the gavel comes down, either
in person or virtually, and then by seniority of Members
arriving later, alternating between Republicans and Democrats.
I often begin these hearings by taking us back to 2008, and
to the years that followed, because we are still living with
the fallout, and in the case of the LIBOR scandal, we are still
cleaning up a mess caused by the biggest banks in the world,
still cleaning up a mess more than a decade later.
As the housing market crashed and more than eight million
workers lost their jobs, central bankers began to realize just
how many markets were broken in the global economy.
One of those was the interest rate system. Most people had
never heard, maybe still have never heard of LIBOR. Like so
much in the financial system, it is an opaque term for
something that affects millions of people's bills and bank
accounts and ultimately lives. LIBOR has been the most widely
used interest rate benchmark around the world. It is used to
set payments for millions of student loans, mortgages, and
small business and auto loans. Some $300 trillion--three
hundred thousand billion dollars--was tied to LIBOR at its
peak. With that kind of money involved, it should surprise no
one that bankers figured out a way to conspire to rig the
interest rate, to enrich themselves.
After the scandal broke in 2012, uncovering the banks'
manipulation of LIBOR, this Committee and the Federal financial
regulators studied the problems to determine who was at fault.
U.S. and foreign regulators imposed billions of dollars in
fines on several global banks for manipulating the interest
rate and taking advantage of consumers and investors.
Now, nearly a decade later, our financial system is finally
transitioning away from LIBOR. Today we will consider how the
financial system can move on from this benchmark set by a
handful of the world's largest banks, a system we found out was
ripe for exploitation. Part of that transition involves dealing
with trillions of dollars in legacy contracts tied to LIBOR,
and that will continue after the rate is discontinued in June
of the year after next, of 2023.
After a slow start, the Federal Reserve Bank of New York
and the Federal Reserve Board here, along with industry
stakeholders and consumer advocates, have established a path
forward. They developed, as we know, a new, more reliable and
transparent benchmark rate called SOFR, the Secured Overnight
Financing Rate, and they have put forward a framework to
address legacy loans and contracts that were written assuming
that LIBOR would always exist.
Because LIBOR is so widely used, homeowners and students
who have never heard of LIBOR will be at risk when it is
discontinued if we do not take action, and I am particularly
appreciative of Senator Tester and Elizabeth and the work they
are doing, and Senator Tillis also on that. If their loans do
not have specific instructions about what happens if LIBOR
disappears, or if their loans give loan servicers the
discretion to pick a different rate, those borrowers would be
in for a shock.
Small and large businesses could be in a similar situation,
forced to negotiate a loan tied to LIBOR at a time when they
are just getting back on their feet from the pandemic.
Banking agency officials and stakeholders have all said
Federal legislation would help address those long-term loans
and contracts, and reduce the potential for time-consuming and
costly litigation.
Our colleagues on House Financial Services began bipartisan
work on a bill that addresses these problems, and as I
mentioned, Senators Tester and Tillis are preparing a Senate
companion. If done right, this legislation can help borrowers
who do not have the ability to bargain with their student loan
lender or mortgage banker, while also providing certainty to
lenders. We know we need to act, and I appreciate these efforts
by Members of our Committee.
Under the current proposal, lenders with legacy contracts
that do not specify a LIBOR alternative can transition to SOFR,
so long as they do not make other changes that could harm
borrowers. That would allow them to avoid potentially
complicated litigation.
It is frustrating that we are forced to spend taxpayers'
time and money cleaning up after the biggest banks, again and
again and again. Unfortunately, if we do not work to mitigate
the damage from another big bank scandal it is always family
businesses and homeowners and students and consumers who will
pay the price.
Our witnesses and their organizations have developed a
narrow and consistent solution that protects small businesses,
and families with mortgages, and Americans paying off student
loans.
I look forward to hearing from our witnesses, and to
working with my colleagues to protect consumers and to protect
the economy. We have proven we can come together on this
Committee. We try to do it often and we succeed sometimes, to
find areas of agreement, and to advance commonsense solutions
for the people whom we serve. My hope is we can do the same on
LIBOR.
Senator Toomey.
OPENING STATEMENT OF SENATOR PATRICK J. TOOMEY
Senator Toomey. Thank you, Mr. Chairman, and welcome, and
thank you to our witnesses today.
LIBOR, the London Interbank Offered Rate, has long been the
most widely used U.S. dollar-denominated benchmark interest
rate across all types of financial contracts. 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 volumes.
As the breadth and depth of interbank loan deposit 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. SOFR
measures the cost of overnight or short-term borrowings
collateralized by U.S. Treasury securities.
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. The administrator of LIBOR will
stop publishing all LIBOR settings by June 30, 2023. And
although most existing contracts referencing LIBOR will have
matured by that date, a number of contracts will not, and some
lack the fallback language to replace LIBOR with a non-LIBOR
index. As a result, many have called for Federal legislation to
address these so-called ``tough legacy contracts.''
Now I agree banks should stop writing new LIBOR contracts
as soon as it is practical, and Federal legislation is likely
needed to address tough legacy contracts. The unique and
anomalous circumstances related to the LIBOR transition
probably require action by Congress to amend contracts between
private parties, but such congressional action should be a last
resort.
As we consider this measure, any legislation that addresses
these tough legacy contracts must be very narrowly tailored,
should not change the equities of these contracts, and they
certainly should not affect any new contracts.
In July, the House Financial Services Committee approved a
bill that would replace LIBOR in these legacy contracts with a
Fed-selected, SOFR-based benchmark. The bill takes a reasonable
approach, and the Senate should carefully review it. In so
doing, we should consider targeted amendments, such as ensuring
that qualified non-SOFR benchmark rates are not disfavored in
future contracts.
While it is appropriate to mandate a SOFR-based index for
this relatively small universe of tough legacy contracts, for
new contracts banks should have the option to choose among
qualified benchmark rates, including credit-sensitive rates, to
the extent they are appropriate for their business models.
Risk-free rates like SOFR may work well for some derivatives
contracts and for some 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
only SOFR. The Fed, FDIC, and OCC have previously acknowledged
this dynamic. They have said the use of SOFR is voluntary and a
bank may use, and I quote, ``any reference rate for its loans
that the bank determines to be appropriate for its funding
model and customer needs,'' end quote.
An even broader group of regulators said, in the context of
bank lending, that, and I quote, ``supervisors will not
criticize firms solely for using a reference rate (or rates)
other than SOFR,'' end quote. I think that is very important,
which is why I am concerned this may be what the Biden
administration financial regulators are actually not pursuing.
Just last week, the Acting Comptroller of the Currency said
the OCC's supervisory efforts will, quote, ``initially focus on
non-SOFR rates,'' end quote, which suggests to me 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, quote, ``extra work,'' end
quote, to ensure that the bank is, quote, ``demonstrably making
a responsible decision,'' end quote.
The SEC Chairman, Gary Gensler, has been even more
explicit. On multiple occasions he has criticized one
particular credit-sensitive rate. So these statements raise
serious concerns that regulators, some regulators, are pressing
all banks to use SOFR without any transparency or public input.
It seems to me if a bank wants to price its loan off a rate it
believes is a better reflection of its cost of funding or its
customer needs than SOFR and regulators should not prohibit the
bank from doing so.
This pressure, however, pales in comparison to the
preferred approach of President Biden's proposed nominee to
lead the OCC. Professor Saule Omarova has written that widely
used benchmark rates should either be preapproved by the
Government, or worse, subject to, quote, ``utility-style
regulation,'' end quote. 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 economic and market 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 these tough legacy contracts, and ways to preserve
benchmark rate choice.
Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Toomey.
I will introduce today's witnesses. Mr. Thomas Wipf serves
as Chair of the Alternative Reference Rate Committee, which was
convened by the Federal Reserve Board to help ensure successful
transition from LIBOR to a more modest reference rate. Mr. Wipf
is a Managing Director at Morgan Stanley.
Mr. Andrew Pizor is Staff Attorney at the National Consumer
Law Center's Washington office, where he works on issues
related to mortgage financing and defending homeowners from
foreclosures. He has served as an expert witness on mortgage
origination and servicing issues.
The Honorable Christopher Giancarlo is a Senior Counsel at
Willkie Farr & Gallagher and previous Chair of the Commodity
Futures Trading Commission. I often saw him on the Agriculture
Committee and sometimes here. In that role, he oversaw
regulation of futures options and swaps derivatives markets. He
has testified often about financial and derivatives markets
before Congress and to the EU Parliament.
Mr. Michael Bright, also no stranger here, is Chief
Executive Officer of the Structured Financial Association. He
is Executive Vice President and COO of Government National
Mortgage Association, Ginnie Mae. He was a director at the
Milken Institute Center for Financial Markets, and we first
worked with him when he worked in the office of Senator Robert
Corker.
Mr. Wipf, please begin. You are recognized for 5 minutes.
STATEMENT OF THOMAS WIPF, CHAIR OF THE ALTERNATIVE REFERENCE
RATE COMMITTEE (ARRC) AND MANAGING DIRECTOR, MORGAN STANLEY
Mr. Wipf. Thank you, Chairman Brown, Ranking Member Toomey,
and Members of the Committee. I am honored to be here today on
behalf of the Alternative Reference Rates Committee, the ARRC,
to testify on the need for Federal legislation to address U.S.
dollar LIBOR transition for legacy products and support the
efforts of the Committee to bring that to fruition.
The ARRC is comprised both of a broad set of private-sector
firms and associations representing a range of perspectives on
the LIBOR transition as well as a broad set of U.S. agencies,
including the Federal Reserve, the CFTC, the SEC, Treasury, the
OCC, the FDIC, and the FHFA, who observe our work. We were
convened by the Federal Reserve Board and the Federal Reserve
Bank of New York in 2014, in order to help address the
financial stability risks that the Financial Stability
Oversight Council had publicly identified concerning the use of
LIBOR in the financial system.
ARRC working groups have involved thousands of participants
across more than 300 different institutions including lenders,
borrowers, investors, and consumer advocacy groups. The ARRC
has estimated that U.S. dollar LIBOR is referenced in over $200
trillion notional financial contracts alone, and that roughly a
third of these contracts will remain outstanding as of June 30,
2023, when LIBOR will cease.
The ARRC was convened to help facilitate a smooth
transition and was asked to identify a robust alternative to
U.S. dollar LIBOR, one that was appropriate to base trillions
of dollars of contracts on, and to address risks to legacy
LIBOR contracts.
The ARRC selected the Secured Overnight Financing Rate, or
SOFR, which is the U.S. Treasury repo market, as its
recommended alternative, based on the fact that it is by far
the most robust alternative to LIBOR available.
There will always be a U.S. Treasury repo market both in
good times and bad, and based on the widespread support from a
broad range of market participants including end users and
borrowers, we now expect that many market participants will
choose to use SOFR, and many have already done so or are
actively preparing to do so. However, we also support choice,
and we have been clear since our inception that our
recommendations are voluntary. At the end of the day, the
market will determine which rates are used in the future.
For many existing legacy contracts that reference LIBOR,
however, things are much less simple. Many legacy non-financial
corporate contracts referencing LIBOR have no fallback language
whatsoever. Many financial contracts have fallbacks that would
require parties to poll an unnamed set of banks in an attempt
to recreate LIBOR, which we believe would be both burdensome
and unsuccessful. Others refer only to the last published value
of LIBOR, effectively converting what were floating-rate
instruments into fixed-rate instruments. These contracts are
difficult or impossible to change in the absence of a
legislative solution. Without legislation, parties to these
tough legacy contracts will face significant operational and
market disruptions, contractual disputes, and economic
hardship.
To help address this risk to these tough legacy contracts,
the ARRC developed and promoted legislation for contracts
governed by New York law to avoid the disruptions, market
uncertainties, and confusion that would otherwise occur when
LIBOR ends. The passage of State legislation in New York, and
subsequently also in Alabama, has been extraordinarily
important, helping to address the risks of the LIBOR
transition. In particular, many financial contracts are covered
under New York law. However, we know that many nonfinancial
corporate contracts, consumer loans, and securitizations are
not covered.
So while the ARRC is prepared to advocate for similar
legislation in other States, we cannot reasonably hope for a
comparable legislative solution in all 50 States and the
District of Columbia. Federal legislation can help to ensure an
equal outcome for all Americans. The legislative proposal
before your Committee would help to ensure that equal outcome.
As with the legislation passed in New York and Alabama, the
legislative proposal is purposefully narrow, intended only to
address contracts that could not otherwise be changed. For
contracts that already allow one party the right to choose a
new rate, a feature of most consumer contracts referencing
LIBOR, the proposed legislation does not alter the right of the
designated party to determine the successor rate, but the
legislation does provide safe harbor to encourage a choice
based on SOFR, which has had the strong support of consumer
advocacy groups in addition to lenders and investors, and this
is intended to help ensure that consumers are treated fairly in
this transition.
For contracts that have no fallback language or language
that only refers only to a poll of banks or some past value of
LIBOR, the proposed legislation recognizes that a unique
successor rate must be named in order to avoid legal conflict.
We believe that this form of tailored legislation is
appropriate and necessary to avoid disruption to the economy.
We support the legislative proposal before your Committee,
are grateful for your consideration of it, and on behalf of the
ARRC I thank you.
Chairman Brown. Thank you, Mr. Wipf. Mr. Pizor, you are
recognized for 5 minutes. Thank you for joining us.
STATEMENT OF ANDREW PIZOR, STAFF ATTORNEY, NATIONAL CONSUMER
LAW CENTER
Mr. Pizor. Chairman Brown, Senator Toomey, and Members of
the Committee, we thank you for the opportunity to testify
today on the importance of protecting consumers from
potentially higher loan costs that could be triggered when the
benchmark LIBOR index ends. I provide my testimony here today
on behalf of NCLC's low-income clients.
My primary message is to encourage the Senate to support
H.R. 4616 but within a central change, a more limited safe
harbor. With this change, H.R. 4616 will protect both consumers
and the credit industry from possibly devastating consequences
from the transition away from the LIBOR.
The LIBOR is used to adjust the rate on more than $1
trillion of consumer mortgages, student loans, and other credit
contracts. When LIBOR ends in less than 2 years, the credit
industry must substitute a new index. If the transition is not
done correctly the resulting higher loan payments could force
millions of consumers into default and lead to widespread
litigation against industry.
The typical adjustable-rate loan allows the creditor broad
discretion to choose a replacement index, but there is no exact
replacement for the LIBOR. So without clear legal protections,
both consumers and industry could be at risk, consumers from
higher payments that could trigger defaults and industry from
lost profits and litigation.
Additionally, some contracts require other adjustments when
a new index is used. These adjustments are called conforming
changes because they bring the contract into conformity with
the replacement index. However, there is no consensus on how to
determine what these conforming changes are or their legality.
Based on our experience with predatory lending and problems
in the loan servicing industry, we are concerned that some
companies may abuse or mismanage their discretion by trying to
gouge consumers. There are several possible scenarios for how
this could happen. Our biggest fear is that the lender could
pick a replacement index that unfairly increases the loan
payments, or under the guise of conforming changes a lender
might change the method for calculating payments or the margin
used to set the interest rate. Consumers have no control over
this process. If harmed, their only recourse will be to sue.
Because this issue affects such a broad range of the
economy, industry participants, Government regulators, and
consumers groups have been meeting to discuss possible
solutions. These meetings have produced a consensus that the
best replacement for the LIBOR is the SOFR. But these groups
cannot force anyone to use it, and it is not clear how many
companies will voluntarily adopt it for legacy contracts. We
understand that note-holders are delaying this decision because
of concern over litigation risk.
Currently the House is considering H.R. 4616. This bill
includes several provisions that deal with replacing the LIBOR.
For consumers, the single most important creates a safe harbor
for note-holders that voluntarily use the appropriate version
of the SOFR to replace the LIBOR.
The current bill includes broad immunity from lawsuits when
SOFR is selected and the related conforming changes are made.
We support the concept of a safe harbor, but the current
language is just too broad and could allow bad actors to escape
responsibility, even when they hurt consumers.
Now we have discussed this problem with industry and we
have agreed on some adjustments to the safe harbor language
that would enable us to support it. My written testimony has
the details on this point.
But overall, it is very important for Congress to adopt
legislation that encourages note-holders to use the SOFR in
legacy contracts when the LIBOR ends. This is important enough
that we are actually supporting creating a safe harbor for
note-holders, something we would not normally do, but it is
equally important that the safe harbor be narrowly tailored so
it is not abused.
I want to conclude by thanking industry, the Members of
this Committee, and the House Committee for working with us to
find a solution that helps everyone, and I am happy to answer
any questions you may have. Thank you.
Chairman Brown. Thank you. Mr. Giancarlo, you are
recognized for 5 minutes. Thank you for joining us.
STATEMENT OF J. CHRISTOPHER GIANCARLO, SENIOR COUNSEL, WILLKIE
FARR & GALLAGHER LLP, AND FORMER CHAIRMAN, U.S. COMMODITY
FUTURES TRADING COMMISSION
Mr. Giancarlo. Chairman Brown, Ranking Member Toomey, and
Members of the Committee, thank you very much. It is good to be
before you once again.
I am Chris Giancarlo, Senior Counsel at Willkie Farr &
Gallagher. I am the former Chairman of the CFTC, an agency that
has led and continues to lead the transition away from LIBOR. I
am also an independent director of the American Financial
Exchange.
I have extensive experience both as a market regulator and
as a business executive with financial benchmarks, and
particularly with LIBOR. During my 5 years at the CFTC I
traveled across the country to meet with Americans and
businesses who depend on futures markets to hedge the prices of
products and commodities they produce. I walked factor floors
in Illinois, pecan farms in Georgia, grain elevators in
Montana, feed lots in Kansas, and power plants in Ohio. I went
900 feet underground in a Kentucky coal mine, 90 feet in the
air in a North Dakota natural gas rig, and flew 900 feet in the
air in an Arkansas crop duster.
Almost all of the small and medium-sized businesses that I
met were supported by America's community, minority, and
regional banks. I support open and competitive U.S. markets,
but my comments today are frankly less about the need for
competition but more about choice of complementary benchmarks.
America's trading markets feature a diverse set of pricing
benchmarks serving different needs. In our grain futures
markets, there are multiple pricing benchmarks, including
Chicago's soft red winter wheat, Kansas City hard red winter
wheat, and Minneapolis hard red spring wheat. The different
benchmarks serve to establish the cost of different varieties
of wheat used in different bread products. Pizza dough, for
example, is made from different wheat than breakfast cereals.
In our oil markets there are also different benchmarks.
West Texas Intermediate and Brent crude oil, again, setting
distinct prices for different fuel products like domestic auto
gas or industrial oil.
And, of course, in our equity markets there are multiple
benchmarks like the Dow Jones Industrials, the S&P 500, and the
Russell 2000 to measure the different performance of large
multinationals compared to early stage growth companies.
Such variety of specifically designed benchmarks allows
market participants to make choices that are right for their
investment needs rather than a one-size-fits-all approach.
Choice of benchmarks is a reason why U.S. futures and equity
markets are the envy of the world.
Strangely, one U.S. market that has not a similar range of
choice of benchmarks is bank lending, where LIBOR has been
dominant for decades. In fact, the ubiquity of LIBOR in
American commercial lending is one of the reasons why ending it
presents such a potential crisis today. Lack of choice of
benchmark is itself a systemic risk.
The United States banking industry is unlike any other in
the world. On one hand, our large money center and Wall Street
investment banks lead the world in global trading, investment
banking, and large project finance. But on the other hand, our
community, our minority, and our regional banks spread out
across the urban, suburban, and rural landscape finance the
everyday needs of America's consumers, small and medium-sized
businesses, minority communities, and domestic job creators.
A banking industry that is so varied, so complex, and so
essential to our economy needs the diversity and durability
that comes from choice of interest rate benchmark. A one-size-
fits-all approach would be a source of systemic risk to the
U.S. economy.
As we move away from LIBOR, we must be clear that lending
institutions, be they large money center banks or local,
regional, or MDI banks, should have the flexibility to choose
amongst appropriate benchmark alternatives that meet their
customer needs.
I urge you to consider legislation ensuring that America's
community lenders have the ability to choose among sound and
properly qualified benchmark replacement that meet the
international standards based upon robust markets with
transparent price discovery. Having choice among multiple
qualified benchmarks not only facilitates the transition away
from LIBOR but it also enhances efficiency, reduces systemic
risk, and encourages economic growth for generations to come.
Thank you.
Chairman Brown. Thank you. Mr. Bright, welcome to the
Committee. You are recognized for 5 minutes.
STATEMENT OF MICHAEL BRIGHT, CHIEF EXECUTIVE OFFICER,
STRUCTURED FINANCE ASSOCIATION
Mr. Bright. Chairman Brown, Ranking Member Toomey, and
other Members of the Committee, my name is Michael Bright, CEO
of the Structured Finance Association, or SFA. On behalf of the
member companies of SFA I thank you for inviting me to testify.
I also thank you for your focus on finalizing the transition
away from LIBOR for millions of consumers and investors.
The Structured Finance Association is a consensus-driven
trade association with over 370 institutional members. SFA
members include issuers and investors, data and analytic firms,
law firms, servicers, accounting firms, and trustees.
Importantly, our investor firms are fiduciaries to their
clients. Unlike some trade associations, before we take any
advocacy position our governance requires us to achieve
consensus rather than a simple majority.
Let me first make abundantly clear that many of SFA member
companies were impacted by the LIBOR scandal. We need to ensure
that this never happens again. Contracts based on a floating
rate index must be able to rely on the integrity of that index.
This is a critical component of the work SFA is engaged in
today.
The cessation of LIBOR has been an enormous challenge
overhanging the capital markets since 2017. At that time, the
Financial Conduct Authority, LIBOR's regulator based in London,
announced that the production of LIBOR would likely end in
2021. Over the subsequent years, extensive progress has been
made to move away from these rates. Today, out of over $200
trillion of contracts that are tied to LIBOR in the U.S.,
nearly all have managed to put in place a plan for transition.
Even with this multiyear effort, however, SFA estimates
that roughly $16 trillion of contracts have no realistic means
to be renegotiated and amended. These so-called ``tough legacy
contract'' were made prior to knowing LIBOR was going away.
These include mortgages, student loans and business loans, and
therefore impact a broad range of American households and
communities. Sixteen trillion dollars is a large sum, posing
serious risk to the financial system.
After lengthy deliberation and debate, a consensus position
across the entire market has emerged that a Federal safe harbor
for the transition of these tough legacy contracts is the only
option to avoid costly litigation and consumer disruption. The
many other alternatives examined simply did not work. We now
see that absent Federal legislation to provide a safe harbor,
retirees and savers will be forced to absorb tens of billions
of dollars in legal costs.
But legislation can offer a solution. A tailored safe
harbor can provide certainty for all parties in a LIBOR
contract. If done properly, SFA believes that legislation will
respect some important principles. For one, legislation to
address LIBOR should not create any value transfer among
contractual parties. The safe harbor should be as narrow as
possible. Legislation should not impact choices of rates for
new contracts but should instead focus solely on legacy
contracts. And finally, legislation should not disrupt
contracts that have adequate fallback language in them already.
With these principles in mind, SFA is strongly supportive
of the bill that recently passed out of the House Financial
Services Committee. Simultaneously, on behalf of the entire
membership of SFA, I specifically want to thank Senators Tester
and Tillis for the leadership they are providing on this issue
in the Senate. We are here to provide any assistance that you
all need.
Timing is critical. While market participants are working
tirelessly to transition contracts that allow it, loans and
tough legacy contracts are in limbo. Rulemaking by the Fed
takes time, as will implementation of those rules. So while the
formal date for the end of most LIBOR rates is now mid-2023,
the problems and legal costs begin much sooner.
In conclusion, let me thank you all again for your focus on
helping to move our markets away from LIBOR once and for all.
This work is critical to ensuring that all investors,
consumers, and businesses are treated fairly. It also will help
to prevent billions of dollars of potential litigation where no
one wins but savers and retirees foot the bill.
Thank you, and I look forward to answering any questions
that you have.
Chairman Brown. Thank you, Mr. Bright. All of you obviously
have been essential in your work on the LIBOR transition. I
would like to ask each of you, and I will start with Mr. Wipf,
to concisely and briefly just tell us why it is important to
have Federal legislation to deal with the problematic legacy
loans and contracts. Mr. Wipf.
Mr. Wipf. Thank you, Senator. As it relates to tough
legacy, as we work through this, there have been many, many
contracts that will be amended bilaterally by market
participants. As we get down to the most challenging contracts
with a tough legacy it is critical that we have legislation to
the extent that it will help smooth that over, and as has been
mentioned here, minimize value transfer, and present a fair,
effective, and clear approach. And that clarity to reduce
uncertainty for those borrowers and lenders in those contracts
will be critical, and I think time is of the essence because we
are really in a position where absent a solution, many of those
note-holders and others may have to take action away from that.
So our goal really here is to present that fair, effective,
and clear solution to those toughest legacy contracts, which
really is one of the final pieces of this transition puzzle and
will help us close the book on this.
Chairman Brown. Mr. Pizor.
Mr. Pizor. Thank you. We are concerned that the industry is
just paralyzed by litigation risk at this point. They need some
clarity because they are worried that no matter what index they
choose they are going to be sued. If payments go up or if
payments go down, consumers and investors will be affected.
So our first choice would be that Congress require use of
the SOFR in legacy contracts, but we understand that is not
going to happen. So we think a safe harbor will be a good
inducement to choose the SOFR. It will eliminate the litigation
risk and we are confident that it has been carefully vetted
that it is the closest to the LIBOR.
Congress needs to do this because there just is not time
for all 50 States to do it, and that will provide the clear
guidance, clear playing field for the legacy contracts to move
forward until they are terminated.
Chairman Brown. Thank you. Mr. Giancarlo.
Mr. Giancarlo. Quite briefly, it is about moving away from
the benchmark that is deeply engrained to the U.S. economy and
has been for four or five decades now, underlying so much of
what we do, from the consumer level all the way up to our large
institutions, and to do so in a way to move away from this with
a minimum amount of adverse impact on our economy, legal costs,
legal uncertainty, economic costs. So it is about clarity,
legal certainty, and reducing the trauma to the economy of this
transition.
Chairman Brown. Mr. Bright.
Mr. Bright. Yeah. Echoing everything everyone here has
said, without legislation, contractual parties are going to see
court guidance on what rates to use, and if they do that,
consumers will get different rates and maybe disparate
treatment there, and also importantly, that costs a lot of
money, tens of billions of dollars, we estimate. Those costs
float down through to the investor because often savers,
retirees, and so it is just court costs that we should avoid.
Chairman Brown. Thank you. Mr. Pizor, you mentioned the
discussions among consumer and industry groups on consensus
language to further tailor the legislation to better protect
consumers. Give me your thoughts on why that is important,
benefiting borrowers and lenders.
Mr. Pizor. I am sorry. I did not hear your quite----
Chairman Brown. Why those changes protecting consumers are
important and why they would benefit borrowers and lenders?
Mr. Pizor. Well, there are certain expectations that all
the parties have had going into these contracts. And again, I
just want to emphasize we are focusing on the legacy contracts.
People have had expectations about what the LIBOR would do,
what their rates would be like in the future. And so it is
appropriate that whatever index replaces that should be as
close as possible to the LIBOR to match those expectations, and
that will be the SOFR.
Now we are willing to support a safe harbor to encourage
companies to do this, but it needs to be properly tailored so
the safe harbor only encourages selection of the SOFR and
making appropriate conforming changes. We do not want bad
actors to see this as an opportunity to encourage some extra
transfer of value.
The current language in the House bill, we are concerned,
is so broad that it would allow bad actors to escape liability
for taking opportunity to gouge consumers. But we think we have
agreed with industry on some substitute language that will meet
everyone's needs. It will give a safe harbor for doing the
proper conforming changes, for choosing the SOFR, but it will
not allow people to run amok. And we think it is a very viable
option.
Chairman Brown. Thank you. Mr. Wipf, last question. LIBOR
will not be published until June 2023, as you know, and you and
ARRC and other stakeholders have indicated it is important for
Congress to act soon, even though that is 2 years away. Mr.
Bright said timing is critical just a moment ago. What will
that lead time allow for? Is there a risk of acting too slowly?
Mr. Wipf. Yes, I think there is. I think our history in the
New York legislation gives us a sense that that builds a lot of
confidence. So as market participants see these outcomes taking
place and they see progress on these legislative paths that
gives comfort to the market and I think allows good market
functioning while these things take place. But we are in a
pretty short time zone with 18 months after the end of this
year that, you know, you think about investors that hold these
securities, borrowers and lenders who do not have the ability
to amend these contracts may have to take other action, whether
that be--you know, and we want to reduce the prospect of fire
sale on these securities and we want to reduce the prospect of,
you know, litigation as we get there.
But the goal really is to provide that confidence to the
market that we are moving down a path, and I think that
certainly the New York State legislation showed us that that
can be helpful, so I think we are in a pretty tight shot clock
right now.
Chairman Brown. Thank you. Thank you all. Senator Toomey.
Senator Toomey. Thanks, Mr. Chairman. For Chairman
Giancarlo, in your testimony you talked about two fatal flaws
that required and led to the transition of LIBOR. One was the
shallowness of liquidity, by which I think you were referring
to a thin trading volume. The other one was the narrowness of
liquidity, as you put it, by which I think you meant a small
number of banks that would participate in establishing LIBOR.
So it seems that a problem with inadequate liquidity is
that the rate that is determined might not accurately reflect
actual borrowing and lending costs, and therein lies problem.
So could you help explain for us how it is that SOFR, Ameribor,
and maybe other alternatives rates avoid these pitfalls, which
is the shallowness and narrowness of liquidity not a problem in
these other rates?
Mr. Giancarlo. Thank you, Senator Toomey. You know, both at
my 5 years at the CFTC but also the decade and a half I spent
before that as a senior executive of a firm that actually
managed marketplaces for market makers, one of the largest
marketplaces for a range of sophisticated financial products
called swaps, and others, so I have spent part of my
professional career considering the challenge of liquidity in
trading markets.
And there is a phrase called the ``liquidity puzzle,'' that
people that are active in marketplaces understand. Liquidity is
never one number or one feature. There are a number of facets
that go into liquidity. And LIBOR suffered from a failure in at
least two of the most important facets, and that is that the
trading volume was actually quite shallow. In a number of the
tenors of LIBOR there is less than a dozen trades a day. But
another factor was the limited number of actually participants
in that market, a half dozen or so Wall Street banks.
So there is a lot that goes into healthy liquidity. As we
talked about, depth is one. Breadth and diversity of market
participants is another. Concentration is another. Is the
liquidity provision concentrated amongst a small number of
firms?
And then there is the question of access to the liquidity.
Is the liquidity available to all participants, and if so, at
what cost? Are there different cost factors for some
participants? And then finally dynamics. Under what market
conditions does that liquidity diminish or does it expand?
Senator Toomey. And just briefly, do these other indices,
are they clearly superior in all of these aspects of liquidity
to LIBOR?
Mr. Giancarlo. Indeed. I think a lot of the qualified
benchmarks that we are talking about today address a lot of the
shortcomings of LIBOR, but address it in different ways,
because--and the point I am looking to make is that market
participants have different needs for liquidity at different
times and different types of liquidity, and the different
alternative benchmarks present superior aspects to LIBOR and a
number of these different liquidity factors.
Senator Toomey. And I think you shared the view that that
is part of the reason why it is important that financial
institutions have a range of choices in setting a benchmark
that suits their business model, their customers' needs, and so
on.
Let me move on to another issue, which is, as I mentioned
earlier. President Biden's nominee to lead the OCC, Professor
Saule Omarova has proposed a fundamentally different approach
to benchmark rate regulations. In a paper on, quote,
``systemically important prices,'' end quote, or SIPIs, as she
calls them, she proposes, and I quote, ``requiring licensure or
preapproval of private institutions that establish or maintain
widely used benchmarks which receive SIPI designation,'' end
quote. And alternatively she suggests something that she
describes as utility-style regulation of benchmark rates, for
example, through a SIPI rates ports.
So, in other words, what she is advocating is that the
Government, not just the market but the Government play a
direct role in actually setting interest rates to be used in
commercial contracts.
Given your experience as a regulator in the private sector,
do you think it is a good idea for the Government to decide
what interest rates are generally on a given day?
Mr. Giancarlo. So I have experience with this, because the
European approach, the continental EU approach, is often to
dictate what components go into a benchmark and what the
formula must be. And the problem with that is benchmark
providers then design their benchmark to meet regulatory
standards, as opposed to what I might call the more American
approach is that benchmark developers develop the benchmark to
meet commercial standards.
And there is a big difference between a benchmark that is
designed to meet the commercial needs and where commercial
enterprises, if they do not feel that benchmark adequately
reflects the characteristics they are looking to can go to a
different benchmark, as opposed to regulators saying, ``We are
only going to let there be so many benchmarks and they need to
meet these regulatory requirements,'' which then can be abused
politically, because you could see that regulators say, ``Well,
we have a constituent here who feels he is underweighted in
your benchmark so you need to adjust your benchmark to meet
these political--''
Senator Toomey. I get that distinction in how you design
the benchmark, but is it not an order of magnitude beyond that
if you are advocating that there be some Government
representation in terms of the actual setting of the rate on a
given day?
Mr. Giancarlo. Yes, indeed.
Senator Toomey. Yeah. Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Toomey. Senator Reed of
Rhode Island is recognized for 5 minutes.
Senator Reed. Thank you very much, Mr. Chairman. Let me
thank the witnesses for their very hard and thoughtful work on
this very important topic. I appreciate all you have done.
Mr. Pizor, what kind of protections should Congress and the
banking agencies consider in order of prioritizing interest of
consumers during this transition?
Mr. Pizor. Well, I think it is very important that Congress
prioritize fairness in the selection of the rates. As I
mentioned, people who have the LIBOR already in their contract,
they know what their payments are going to be, they have
expectations about how much the payments are going to change,
and the SOFR is really the only one that can match those
expectations going forward for legacy contracts.
So we need Congress to ensure that this fairness in the
selection of the rate, that no one uses that as an opportunity
to, you know, seek it as a profit-making opportunity. It is
really just about fairness of continuing these contracts on the
standards that are already in place.
Senator Reed. So essentially one of the goals would be to
maintain a constant, in parentheses, rate, one that a borrower
expected to have throughout the course of the contract. Is that
fair?
Mr. Pizor. Yes, exactly.
Senator Reed. Thank you. Mr. Wipf--let me find my notes
here--what design features of SOFR ensure that the
vulnerability of LIBOR will not reappear down the road, that we
will not reinvent a LIBOR?
Mr. Wipf. Thank you, Senator. When the ARRC began our work
we looked at what we saw were the fault lines within LIBOR, and
the single biggest, I say, point of failure was the reliance on
expert judgment. So as Mr. Giancarlo described, if we have a
very few underlying transactions that represent the interbank
lending market the rest was filled in by expert judgment by the
panel banks. So we knew that our path at the ARRC was to
determine a rate that will be robust and transaction-based, and
have no reliance on expert judgment.
That path that led us to SOFR over a 2-year public
consultation period was defined at the top priority, that we
could construct a rate that consisted of actual transactions
that could be administered and transparent, durable, robust
over good times and bad. So we identified SOFR as the most
suitable alternative for LIBOR for institutions of all sizes.
It is based on over $800 to $1 trillion in daily transactions
in the highly liquid, overnight U.S. Treasury repo market, from
a wide range of market participants, and is administered by the
New York Fed.
So based on the daily repo market transactions, SOFR is, by
intent and construction, a reliable representative indicator,
and most importantly, puts no reliance on expert judgment, is
entirely transaction based, is robust, durable, and will work
in good times and bad.
Senator Reed. Thinking back to the LIBOR crisis, it was not
expert, it was self-interest that caused the deviations from
what everyone thought was a completely interest-free measure.
And in the mechanism you are setting up there is no financial
self-interest in any of the rate setters. Is that fair?
Mr. Wipf. By having a large dataset of transactions we
reduce that significantly to near zero. The goal really is to
make sure that this is transaction-based, no reliance on expert
judgment, and has a wide dataset, so that $800 to a trillion,
put that side by side with, as Mr. Giancarlo said, less,
perhaps, than $1 billion that was underpinning LIBOR and that
reliance on expert judgment, which we have removed.
Senator Reed. Final question, that is, this has been
adopted in Alabama and New York. Is there any experience yet in
those two States? Has it gone into effect?
Mr. Wipf. So I think at this point what we have seen is
that, you know, certainly contracts are covered by New York law
and provide a lot of confidence for those market participants,
but until we get to the end of LIBOR we are not going to see
how those play out. But the actual fallbacks that are in place
are the same fallbacks that we are talking about here today.
Senator Reed. So you have seen that contracts have been
rewritten already to include SOFR in New York State?
Mr. Wipf. Yes. So that would be the fallback that would be
applied at the end of LIBOR.
Senator Reed. Well, thank you all again very much for the
hard work you have done. This is a very important topic. Thank
you.
Chairman Brown. Thank you, Senator Reed. Senator Hagerty
from Tennessee is recognized for 5 minutes.
Senator Hagerty. Thank you, Chairman Brown and Ranking
Member Toomey. I appreciate your holding this hearing. And I
want to thank our esteemed panel. I appreciate you being here,
making your testimony today. This is indeed an important topic,
as we all know.
It is important to discuss what is potentially needed from
Congress here, as our financial sector transitions from the
LIBOR benchmark rate, which is embedded, literally, in
trillions of dollars of contracts. This issue impacts everyone.
It includes mortgages, student loans, small business loans, and
it needs to be addressed.
The question is how do we accomplish this transition in an
orderly and timely fashion? How do we do it in a manner that
minimizes cost and uncertainty? How do we do it in a way that
protects the interest of consumers and investors? And let me be
clear here. To the extent that preemption of State law is
necessary here, it should be done in a narrowly tailored
manner, one that minimizes adverse Presidential effects.
I am deeply concerned by the potential ramifications if
third-party trustees, who administer certain contractual
provisions in the structured finance market are required to
seek direction through protracted judicial proceedings. I have
seen the estimates that there may be roughly $16 trillion of
legacy contracts, including mortgages, student loans, small
business loans still outstanding after mid-2023, that would not
contain fallback language that would address this transition
from LIBOR.
I have also heard that certain transaction parties, such as
trustees and fixed income deals, have already begun to notify
bond-holders that they will indeed approach the courts for
guidance some 12 to 18 months out prior to the cessation of
LIBOR so that they can be ensured to have legally protected
resolution to continue to make bond payments on time.
So I would like to ask each of the panelists, in turn, to
opine on why legislation is required to fix this as well as the
potential costs and the impact of not getting Federal
legislation and the importance of getting this done very
quickly.
First, Mr. Bright, I would like to turn to you.
Mr. Bright. Thank you, Senator. I think you articulated it
exceptionally well. The reason is that trustees will need to
seek judicial guidance in order to select what rate, you know,
they are going to administer for these contracts that are
silent or that do not have adequate fallback language embedded
in them. And that process is lengthy, which means it will be
very disruptive and confusing for consumers----
Senator Hagerty. And not necessarily consistent either.
Mr. Bright. Completely inconsistent. There is absolutely no
certainty that there is anything that would be followed as a
precedent in these contracts. We have analyzed this in great
detail. These contracts are all very different. They have
slight differences that could lead, you know, one judge to see
it differently than someone else. And so yes, consumers would
not be treated equally. So that is absolutely critical.
The other point that you make, which I completely agree
with, is that these court costs, not only are they lengthy but
they are expensive, and the way these trustee contracts are set
up, these securitization deals are set up, those costs will
flow through to the end investor, and the end investor, these
are fixed-income deals, these are largely retirees, these are,
you know, stable, pension, 401(k) type investors, and they are
going to bear the costs. We have put some estimates down that
we have it in the tens of billions of dollars that just seems
needless, and hopefully with everybody's work we can avoid
that.
Senator Hagerty. Got it. Mr. Wipf, I will turn to you next.
Mr. Wipf. Thank you. I think the way we have looked at this
is that with the work of the ARRC and the work across the
industry on the voluntary solutions to these problems that when
we look at the numbers of $200-plus trillion a third of that
remaining post June of 2023, and working down to this tough
legacy, that what we have seen is an ability for counterparties
to amend these contracts, working all the way through, and we
get down to this small--not relatively small but very large
tough legacy position, where the parties to those contracts
need to take action and need to do something soon.
So I think to the extent that we have seen, again, the
history of the New York State legislation shows us that when
that legislation is in place we can create confidence, and I
think that the legislation that will provide sort of fair,
effective, and clear conclusions. So that is certainty, and
removing that uncertainty from these contracts is absolutely
mission critical to the transition, and as I said earlier,
really one of the last pieces of the puzzle to help us close
the book.
Senator Hagerty. Got it. Mr. Pizor.
Mr. Pizor. The problem with everyone going to court to try
and get a solution to this is it is time consuming, there are
going to be various decisions across the country, and the
delay, all those factors are going to create instability, which
will harm access to credit in the future, it could affect the
price of credit. And those things are certainly bad for
consumers and they are bad for industry as well. So the sooner
Congress can address this the sooner everyone will know what
the roadmap is going forward, and that is just going to make
for a smoother transition.
Senator Hagerty. I appreciate the sense of urgency. I would
like to finish with my good friend, my former classmate, the
Honorable Chris Giancarlo.
Mr. Giancarlo. It is nice to address you as Senator. The
last time I did I think it was as Ambassador, so it is a
delight to see you here in the Senate.
As a great fan of our Federalist system, which I think has
provided so many benefits to our citizens, I think, like you,
cautious whenever we take up Federal legislation that would
override States' rights. But I think this is one case where,
done properly, done in a very narrowly tailored way, I think
this can provide great benefit to the very market participants
you have mentioned, trustees and others, that need legal
certainty here and do not have to overly burden our court
system to try to work out what is the intent here.
But the narrow tailoring is very important. You know, the
American people do not like it when they feel the Federal
Government or others are tipping the scales in favor of perhaps
winners or losers, and I think it is very important we make
clear, outside of tough legacy contracts, that market
participants have choice of benchmark to suit their unique
needs.
Senator Hagerty. Got it. Thank you. Thank you, Mr.
Chairman.
Chairman Brown. Senator Menendez of New Jersey is
recognized for 5 minutes.
Senator Menendez. Thank you, Mr. Chairman. Let me welcome
Mr. Giancarlo, a fellow New Jerseyan, to the Committee, and I
certainly thank you for your previous service.
Today, 3.3 million private student loan borrowers owe an
estimated $80 billion in loans that reference LIBOR. As lenders
transition away from LIBOR, I am concerned about a lack of
protections for borrowers in private student loan contracts.
Mr. Pizor, as lenders transition away from LIBOR does the
existing language in many private student loan contracts allow
those private lenders to choose a replacement reference rate
that is systematically higher than LIBOR, thereby increasing
the borrowers' interest rates?
Mr. Pizor. Yes, it does, and that is one of our concerns.
Senator Menendez. So how can Congress and regulators ensure
that lenders choose a replacement rate that is fairest to the
borrower?
Mr. Pizor. Well, short of mandating the rate, the best
thing Congress can do is to offer a safe harbor from litigation
that will encourage investors to choose that particular rate.
That eliminates the risk of litigation to them, which is costly
and destabilizing. The end result will work for consumers. And
as long as it is narrowly tailored and does not create an
opportunity for other misconduct we think a safe harbor is the
best way to go to for SOFR.
Senator Menendez. In addition, as you know, the CFPB
proposed rules in June of 2020 that would help facilitate the
transition away from LIBOR. Those rules were supposed to go
into effect back in March of 2021, but they still have not been
finalized. How important would it be for the CFPB to finish its
guidance to private lenders as they transition away from LIBOR,
to ensure that borrowers are not stuck permanently paying
higher interest rates?
Mr. Pizor. That is very important. The guidance cannot be
left to the last minute. Industry needs time to adapt, and so
we hope they will release them as soon as possible.
Senator Menendez. Let me also ask you, most private student
loan contracts include a mandatory arbitration provision which
says that borrowers cannot sue lenders if a problem comes up.
Instead, borrowers have to undergo a one-sided, back-door
arbitration process. Is it possible that a lender could game
the transition away from LIBOR in a way that leads borrowers to
face higher interest loans?
Mr. Pizor. Yes, it is certainly possible, and the existence
of the arbitration clauses in class waivers heightens that
risk, because it effectively eliminates consumers' recourse if
there is misconduct.
Senator Menendez. And would a mandatory arbitration clause
and a class action waiver, both which are common in private
student loan contracts, leave the borrower with no meaningful
path to challenge a lender's actions?
Mr. Pizor. That is correct. Although industry characterizes
arbitration as fair and neutral in practice, we have seen
evidence that it is put into the contracts to essentially
eliminate the opportunity for consumers to challenge
misconduct.
Senator Menendez. Well, our Republican colleagues
successfully repealed the CFPB's arbitration rule. Student
borrowers have little recourse if industry chooses to force
them into higher reference rates. And it is up to Congress and
the CFPB to ensure that student borrowers are not stuck paying
higher interest rates as it goes. We are talking about $80
billion. These are young people who are trying to get underway
in their careers, but between the debt and then the potential
multiplier of the interest rates the consequences are you have
to delaying maybe the purchase of your home, delay the start of
a family, the delay of being an entrepreneur. And that is why I
raise these questions.
Finally, as the Committee discusses LIBOR, I think it is
important to keep the average consumer in mind. Mr. Pizor, is
the average consumer aware that their loan references the LIBOR
rate?
Mr. Pizor. No, I do not think so. It is a complicated issue
and people are not aware of it.
Senator Menendez. Is the average consumer going to have a
say in choosing their replacement rate?
Mr. Pizor. No. None at all.
Senator Menendez. If the lender chooses a rate that causes
a borrower's payment to become unaffordable, do many lenders
offer flexible repayment options?
Mr. Pizor. Unfortunately not.
Senator Menendez. And these are all the consequences that I
am fearful of on the consumer side of the equation, which is
one of the reasons I appreciate your testimony. Thank you very
much.
Mr. Pizor. Thank you.
Senator Menendez. And, Mr. Chairman, I have yielded back 30
seconds.
Chairman Brown. Thank you. That is very generous of you.
Senator Tillis is recognized from his office, remote.
[No response.]
Chairman Brown. Senator Tester, who I have tried to avoid,
is recognized.
Senator Tester. Yeah, thanks. I do appreciate the extra 30
seconds that the Chairman is putting on my time to ask
questions. Thanks for having this hearing, Mr. Chairman and
Ranking Member. Thank you all for being here today. I
appreciate your testimony.
I am going to start with you, Mr. Pizor. LIBOR does impact
everybody's lives and families in ways that most people do not
realize. Can you talk to me about how a LIBOR ending is going
to impact regular folks' lives?
Mr. Pizor. Well, it actually remains to be seen what will
happen, but the risk is pretty significant that payments will
go up, the changes in payments could become more volatile and
unpredictable, and that affects people's ability to budget. And
people are just recovering from the financial trauma of the
pandemic, and to have this instability in monthly payments that
are pretty critical to their lives--home, student loans--it is
a very significant issue.
Senator Tester. Mr. Bright, do you have anything to add to
that?
Mr. Bright. No. I mean, I think you are all addressing the
right concerns. It is going to be very confusing for consumers.
Once they realize this happens, I think the prior question
mentioned that a lot of consumers do not even know that their
rates are tethered to LIBOR. I mean, this would be very
disconcerting, I think, information to get. So if we can all
align on a similar replacement rate with similar communication
strategy, all working together, I think that would really help
quite a bit.
Senator Tester. Mr. Giancarlo.
Mr. Giancarlo. Yes. Thank you. You know, it is important to
remember, as we talk about this, that all borrowers are not the
same. All loans are not the same. Some loans are highly secured
with very liquid capital and collateral. Other loans are
unsecured or secured with fairly illiquid collateral.
You know, the real economy of home builders and auto
dealerships and small manufacturers use collateral that is
quite illiquid. They put plant and equipment liens up, or auto
leases, or home mortgages. And so that type of collateral
causes the borrowers to hold that collateral that they then
need to use--sorry, the lenders--to fund their own operations.
And so one of the reasons why diversity of choice of
benchmark is so important is because those lenders need to be
able to use what collateral they have, relatively illiquid in
many cases, to fund their own operations. And so there needs to
be choice of both credit-sensitive and risk-free borrowing for
an economy as diverse and as deep and as important as the U.S.
economy.
Senator Tester. OK. Mr. Wipf, with your work on ARRC, are
there any other impacts that you think will happen?
Mr. Wipf. What we believe is that the legislation would
provide a structural bridge where these contracts fail, and
remove uncertainty, minimize value transfer, reduce disruption,
and preserve good market functioning. And we think that for the
legacy piece of this we think that SOFR is, you know, far and
away the best choice. We think a single rate is the best
choice. And on a go-forward basis, the ARRC's message has
always been know what is in your reference rate and give the
market those opportunities.
Senator Tester. And I will just stay with you, Mr. Wipf. Do
you see it necessarily as it is just going to happen, that
rates will go up?
Mr. Wipf. I cannot comment on that.
Senator Tester. OK. And does anybody want to comment on
that? Bright, you always comment on something.
Mr. Bright. With the transition from LIBOR to SOFR?
Senator Tester. With the transition with LIBOR going away
and choice being there.
Mr. Bright. So I think if we transition from LIBOR to SOFR,
the recommendations that have come out of a the ARRC committee
and the recommendations that we are looking at, there is, with
a smoothing mechanism of a look-back period so that the spread
between SOFR and LIBOR is calculated over this 5-year average,
and then there is a 1-year onramp to move to that.
So every effort is being made to ensure that there is no
payment shock, rate shock, that those disruptions are as
minimum as possible. You know, since there are still 2 years of
interest rate fluctuations that are getting included in the
calculation of that 5-year lookback, that is hard to predict,
but nobody wants that. That would be very bad.
Senator Tester. OK. So, Michael, I will just stick with
you. So let's just say we have got two folks that live side by
side, and they each have a mortgage, pretty equivalent
mortgage. It is possible that those two neighbors, with LIBOR
going away, is it possible those two neighbors, both at the
same rate today, could end up with different rates as the
benchmark goes away?
Mr. Bright. Without the safe harbor legislation?
Senator Tester. Yes.
Mr. Bright. Yes, that is a real possibility and a concern.
The safe harbor would greatly minimize to eliminate that as a
risk.
Senator Tester. OK. Well, thank you all for your testimony.
I will yield back my 10 seconds, Mr. Chairman.
Chairman Brown. Thank you, Senator Tester. Senator Cortez
Masto is recognized from her office.
Senator Cortez Masto. Thank you. Thank you, Mr. Chairman.
Thank you to the panel members. This is such an important
conversation. And let me also echo what Bob Menendez said, and
I think a panel member said. Most consumers really do not
understand the significance of what LIBOR means and the
transition away from it. So what you all are doing and what we
get right here is so important.
I do commend ARRC's work on making SOFR a robust rate, on a
durable basis. But let me ask you this because we are talking
about the risks right now. Does anybody on the panel not
support transitioning to SOFR? I am just curious. And if you do
not support it, why not?
Mr. Bright. For legacy contracts I do not think anybody has
a problem with SOFR. But I know the Honorable Giancarlo would
like to comment.
Mr. Giancarlo. Agree, but for tough legacy contracts only.
I think Americans traditionally enjoy and benefit from
diversity of choice to suit their individual needs. As I
explained in my testimony, we have a very diverse U.S. economy.
We have large Wall Street banks and we have small community and
minority depository institutions that make loans against very
little or very illiquid collateral, and they have to have the
flexibility that comes from benchmarks that reflect their cost
of funding and not necessary the cost of funding of Wall Street
banks.
So having choice, for everything but tough legacy LIBOR
contracts is critically important, I believe, to the U.S.
economy.
Senator Cortez Masto. And when you talk about choice, Mr.
Giancarlo--and thank you for those comments--choice based on
what? I mean, whose decision? Who gets to determine the rate?
How do you determine that choice?
Mr. Giancarlo. Well, benchmarks have traditionally been
choice by the marketplace. It is actually rare to have
Government authorization of benchmarks. I mean, our lenders are
in the best position to know what benchmarks are probably most
appropriate for their customers and for their cost of funding.
We have both risk-free rates, which are very important and
serve very well for large banks that are primary dealers of
Treasury securities and have large inventory of Treasury
securities, but for our minority, our urban banks, our rural
banks that are not primary dealers of Treasury or hold illiquid
securities, credit-sensitive rates serve their needs quite
well.
And so I think it is not important that we do not put our
fingers on the scale. Now, that does not mean every benchmark
is suitable. I mean, banks are subject to appropriate
prudential standards. They have got to have the right benefits.
And benchmarks that are widely based, all these facets of
liquidity that I talked about, a number of participants not
concentrated amongst a few large dealers, is a very important
aspect, and one of the dynamics of that liquidity as well.
So there are a lot of factors that go in, and I think the
legislation in the House talks about qualified benchmarks,
meaning benchmarks that meet certain global standards. The
International Association of Securities Commissions has put out
global standards that most of the major benchmarks meet, and I
think those standards are important.
So it is not just any willy nilly benchmark. Banks, though,
do know best what meets the needs of their borrowers and their
own cost of funding.
Senator Cortez Masto. And so Mr. Pizor and Mr. Wipf, do you
agree with that, that the banks and financial institutions and
other agencies should have that choice? And if you do not agree
with it, why?
Mr. Wipf. Our view at the ARRC has been, from the
beginning, we go back to first principles. We go back to what
was wrong with LIBOR. And our path to SOFR was to find
something that was robust and durable that other things could
be built upon. So when we look at SOFR, and why we chose this
path, it is the most robust, durable, transparent over time.
Our guidance from the ARRC has been know what is in your
reference rate, because I think if we look back and we look at
the history of LIBOR, that has always been good advice. So when
we look at some of these other rates that are out there, we
would encourage market participants--borrowers, lenders,
issuers, investors--to understand what is in those reference
rates, to know how they are constructed, to understand how they
perform over time--I think we have a reference point back to
March of 2020, that could provide real data--and how do these
things hold up?
We know what SOFR does, and that is why we had a 2-year
public consultation to get to the point of selecting SOFR in
2017. So from the ARRC's perspective, we believe it is far and
away the best choice. As it relates to things that can happen
over and above that for different products, we think that SOFR
still stands as the foundation. Nonetheless, you know, the
ARRC's message is if you are going to use other rates, know
your reference rate.
Senator Cortez Masto. Well, and is not the point here also
to guard against any type of manipulation, like we have seen in
the past with LIBOR?
Mr. Wipf. Our view has been that when we did our work at
the ARRC, and we began our work, we looked at what we thought
the fault lines of LIBOR were. We felt that that is what
brought us to a rate that is entirely based on transactions,
and certainly the most liquid product, the overnight Treasury
repo market, $800 to $100 trillion in transactions, and we
believe that we have minimized that risk as much as can
possibly be minimized.
So because of that, we believe that that solves the problem
that we were trying to solve, which was the ARRC was never set
out to recreate LIBOR. We were trying to find a better solution
to go forward, and we believe SOFR is the best solution.
Senator Cortez Masto. Thank you. Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Cortez Masto. Senator
Sinema from Arizona is recognized from her office.
Senator Sinema. Thank you, Chairman Brown, and thank you to
Ranking Member Toomey for holding this hearing today.
LIBOR and other benchmark interest rates play an important
role in our global financial system. They enable banks and
other financial institutions to manage interest rate risk and
to anticipate changing loan costs. These rates, including
LIBOR, have a very real impact on Arizonans who have taken out
student loans, or mortgages, who have opened lines of credit,
or who have started or invested in a business. So the
transition from LIBOR to the SOFR will be a challenging but
important step toward securing the stability of our financial
system for all investors and consumers.
My first question is for Mr. Bright. Thank you for being
here. There has been some concern about how prepared financial
institutions are to make the transition from LIBOR to SOFR, and
how prepared is the industry to make this transition by the
currently prescribed deadline?
Mr. Bright. Yeah. Thank you very much, Senator, for the
question. It is an important one. So for all contracts that
allow this transition to take place, that is contracts that
have fallback language or are clear that the trustee can make
decisions, or that, you know, the lender can make decisions, an
enormous amount of work has gone into this.
So I feel reasonably confident that industry is there. I
think it is worth everybody being, you know, continuing to be
diligent. The bureau is continuing to promulgate rules for the
industry to use to make sure it communicates with consumers
clearly, and we will follow all of those, and I think that is
important work.
It is the legacy contracts that have been--you know, that
do not have clarity around what rate to transition to, that is
the subject of a lot, I think, of discussion today, and on that
one we are in limbo and we need to get safe harbor passed so
that we can borrow from the preparation work that has been
done, you know, in the other contracts and other loans.
Senator Sinema. Thank you. So my understanding is that the
optical character recognition technology, or OCR, will be
useful in helping companies identify and amend large volumes of
contracts at a relatively low cost. So what other innovative
products or services exist on the market that will help
companies transition from LIBOR to SOFR?
Mr. Bright. So I had not heard of that technology until
your staff mentioned it to us this week, so we researched it a
little. It looks like a helpful tool in helping to identify
what contracts could fall into the umbrella of needing legacy
help or you can do word search and the smart AI type stuff. So
I am not an expert on that but it seems really interesting.
I think as far as technology, you know, you want to look at
the exchanges. So the Chicago Mercantile Exchange and the
Chicago Board of Options Exchange, the CBOE and the CME,
respectively, have done a lot of groundbreaking work to prepare
the markets for this transition. And so those are two places
that I think technology is helpful as well.
Senator Sinema. Well, that is encouraging to hear, but
making this transition more logistically feasible does not
fully resolve the challenges of the tough legacy contracts that
reference LIBOR. So to help Arizonans and Americans make this
transition, what ambiguities need to be clarified by Congress?
Mr. Bright. Again, I think that the legislation that passed
the House does this. It clarifies that if you are in a contract
that is inadequate or lack of clear fallback language that you
have a safe harbor in your transition to SOFR. The Fed will
promulgate rules for that transition. And if the safe harbor is
appropriately tailored, all consumer protections will stay in
place to ensure that communication with consumers is done in
the appropriate and adequate manner.
So I think that I would look to that bill, and Senator
Tester's and Tillis' work in the Senate as well. So that is
probably the best framework.
Senator Sinema. Thank you.
Mr. Giancarlo. And, Senator, if I could just add to that
answer, I think that in addition to the legal certainty for
tough legacy contracts, I think it is very important the
legislation make clear that for all other contracts that there
is freedom of choice for market participants to choose
qualified benchmarks that suit their needs. I think it is very
important that there not be a Government imprimatur place upon
one benchmark or another outside of the tough legacy area, that
for outside of the tough legacy area that consumers and their
bankers have choice of benchmark that suits their particular
needs.
Senator Sinema. Thank you. You know, for my last question I
will ask Mr. Pizor. So I want to ask you, why is this type of
legislative clarity that I was just discussing with Mr. Bright
important to consumers in Arizona, including those who hold
student loans and mortgages?
Mr. Pizor. Well, clarity is especially important for those
two groups of consumers because those payments tend to be very
significant and as a result have a large impact on your monthly
budget. Clarity is also needed in terms of selecting the rate,
that most contracts do not give guidance, and the concept of
conforming changes, which need to be made in conjunction with
changing the rates. The proposed bill, we are hoping, will ask
the Federal Reserve to define conforming changes, and that will
reduce a lot of the ambiguity.
Senator Sinema. Thank you. Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Sinema. We will conclude
the hearing. Thank you to the witnesses for being here. Thank
you for providing the testimony that you gave.
For Senators who wish to submit questions for the record
they are due 1 week from today, on Tuesday, November 9th. To
the witnesses, please submit your response to questions for the
record within 45 days from the day you receive them.
Thank you again so much for being here. The hearing is
adjourned.
[Whereupon, at 11:15 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN SHERROD BROWN
I often begin these hearings by taking us back to 2008, and to the
years that followed, because we are still living with the fallout--and
in the case of the Libor scandal, we are still cleaning up a mess
caused by the biggest banks in the world, more than a decade later.
As the housing market crashed and more than eight million workers
lost their jobs, central bankers began to realize just how many markets
were broken in the global economy.
One of those was the interest rate system. Most people have never
heard of Libor--like so much in the financial system, it's an opaque
term for something that affects millions of people's bills and bank
accounts.
Libor has been the most widely used interest rate benchmark around
the world, used to set payments for millions of student loans,
mortgages, and small business and auto loans. Over three hundred
trillion dollars was tied to Libor at its peak.
With that kind of money involved, it should surprise no one that
bankers figured out a way to conspire to rig the interest rate, to
enrich themselves.
After the scandal broke in 2012 uncovering the banks' manipulation
of Libor, this Committee and the Federal financial regulators studied
the problems with Libor, and who was at fault. U.S. and foreign
regulators imposed billions of dollars in fines on several global banks
for manipulating the interest rate and taking advantage of consumers
and investors.
Now, nearly a decade later, our financial system is finally
transitioning away from Libor. Today we will consider how the financial
system can move on from this benchmark set by a handful of the world's
largest banks--a system we found out was ripe for exploitation. Part of
that transition involves dealing with trillions of dollars in legacy
contracts that are tied to Libor, and that will continue after the rate
is discontinued in June of 2023.
After a slow start, the Federal Reserve Bank of New York and the
Federal Reserve Board, along with industry stakeholders and consumer
advocates, have established a path forward. They developed a new, more
reliable and transparent benchmark rate called SOFR--the Secured
Overnight Financing Rate. And they have put forward a framework to
address legacy loans and contracts that were written assuming that
Libor would always exist.
Because Libor is so widely used, homeowners and students who have
never heard of Libor will be at risk when it's discontinued if we don't
take action.
If their loans don't have specific instructions about what happens
if Libor disappears, or if their loans give loan servicers the
discretion to pick a different rate, those borrowers could be in for a
shock.
Small and large businesses could be in a similar situation--forced
to renegotiate a loan tied to Libor at a time when they're just getting
back on their feet from the pandemic.
Banking agency officials and stakeholders have all said Federal
legislation would help address those long-term loans and contracts, and
reduce the potential for time-consuming and costly litigation.
Our colleagues on the House Financial Services Committee began
bipartisan work on a bill that addresses these legacy problems, and
Senator Tester, working with Senator Tillis, is preparing a Senate
companion.
If done right, this legislation can help borrowers who don't have
the ability to bargain with their student loan lender or mortgage
banker, while also providing certainty to lenders. We know we need to
act, and I appreciate these efforts by Members of our Committee.
Under the current proposal, lenders with legacy contracts that
don't specify a Libor alternative can transition to SOFR--so long as
they don't make other changes that could harm borrowers. That would
allow them to avoid potentially complicated litigation.
It's frustrating that we are forced to spend taxpayers' time and
money cleaning up after the biggest banks, over and over again.
Unfortunately, if we don't work to mitigate the damage from another big
bank scandal, it's family businesses and homeowners and students who
will pay the price.
Our witnesses and their organizations have developed a narrow and
consistent solution that protects small businesses, and families with
mortgages, and Americans paying off student loans.
I look forward to hearing from our witnesses, and to working with
my colleagues to protect consumers and to protect the economy.
We have proven we can come together on this Committee to find areas
of agreement, and to advance commonsense solutions for the people we
serve.
My hope is we can do the same on Libor.
______
PREPARED STATEMENT OF SENATOR PATRICK J. TOOMEY
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.
______
PREPARED STATEMENT OF THOMAS WIPF
Chair of The Alternative Reference Rate Committee (ARRC) and Managing
Director, Morgan Stanley
November 2, 2021
Chairman Brown, Ranking Member Toomey, and Members of the
Committee. I am honored to be here today on behalf of the Alternative
Reference Rates Committee (or ARRC) to testify on the need for Federal
legislation to address the LIBOR transition for legacy products and
support the efforts of this Committee to bring that to fruition.
The ARRC is comprised both of a broad set of private-sector firms
and associations representing a range of perspectives on the LIBOR
transition as well as a broad set of U.S. agencies, including the
Federal Reserve, the CFTC, the SEC, Treasury, the OCC, the FDIC, and
FHFA, who provide oversight to our work. \1\ We were convened by the
Federal Reserve Board and Federal Reserve Bank of New York in 2014 in
order to help address the financial stability risks that the Financial
Stability Oversight Council had publicly identified concerning the use
of LIBOR in the financial system.
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\1\ Reflecting the importance of its work, the ARRC's ex officio
members include the Commodity Futures Trading Commission, Consumer
Financial Protection Bureau, Federal Deposit Insurance Corporation,
Federal Housing Finance Agency, Federal Reserve Bank of New York,
Federal Reserve Board, National Association of Insurance Commissioners,
New York Department of Financial Services, Office of Financial
Research, Office of the Comptroller of the Currency, U.S. Department of
Housing and Urban Development, U.S. Securities and Exchange Commission,
and the U.S. Treasury. As the ARRC has explained, this ``structure
facilitates collaboration between the market and the official sector''
and ``allows the group to have diverse participation across financial
services.''
---------------------------------------------------------------------------
Over time, LIBOR had grown to be a pervasive part of our economy;
it has been referenced in nearly every floating rate business and
consumer loan, floating rate debt and securitization contract, in
nonfinancial corporate contractual agreements, and in a staggering
amount of derivatives. The ARRC has estimated that U.S. dollar LIBOR is
referenced in over $200 trillion financial contracts alone, roughly ten
times the size of the annual U.S. gross domestic product. But despite
the fact that so much of the financial system depended on LIBOR, few if
any bothered to understand what this rate was based on, and in fact we
now understand that it was based on very little. LIBOR had both a weak
and opaque governance structure and was based on what had become a very
thin market. As a result of these shortcomings, LIBOR was in danger of
failing, and the official sector had to step in to prevent a sudden and
disruptive end to it and instead has sought an orderly winddown. The
ARRC was convened to help facilitate a smooth transition and was asked
to identify a robust alternative to U.S. dollar LIBOR, one that was
appropriate to base trillions of dollars of contracts on, and to
address risks to legacy LIBOR contracts. I believe that the ARRC is a
truly successful example of public-private sector cooperation, but it
is important to understand that all of the ARRC's recommendations are
voluntary; no one is required to follow them, and no one is required to
use the ARRC's recommended rate, the Secured Overnight Financing Rate,
or SOFR.
SOFR is based on overnight borrowing transactions in the U.S.
Treasury repo market, the largest interest rates market in the world, a
key source of secured financing for a broad range of financial market
participants, and a key component of overall Treasury markets in the
United States. The ARRC selected SOFR after several years of work
examining all potential alternatives and public consultation. The ARRC
selected SOFR as its recommended alternative based on the fact that it
is by far the most robust alternative to LIBOR available--there will
always be a U.S. Treasury repo market both in good times and bad--and
based on the widespread support from a broad range of market
participants including end users and borrowers.
The ARRC believes that SOFR is an appropriate rate for new use in
products that have historically referenced LIBOR, and that it is robust
enough to ensure that we do not recreate the problems that we have had
to deal with in LIBOR. We expect that many market participants will in
fact choose to use SOFR, and many have already done so or are actively
preparing to. However, we also support choice, and we have been clear
since our inception that our recommendations are voluntary. At the end
of the day, the market will determine which rates are used.
For many legacy products things are much less simple and will
create additional challenges and considerations. The ARRC's Second
Report, published in March 2018, provided a survey of contractual
fallbacks in various cash products referencing LIBOR and noted that
many of these contracts did not envision the possibility that LIBOR
might permanently cease or had fallbacks that would not be economically
appropriate if such an event occurred. Unlike derivatives, which are
covered by standardized documentation and have developed efficient
mechanisms allowing for contractual amendments, many cash instruments,
such as floating rate bonds and securitizations, have fallback language
that is difficult or impossible to change after they have been issued.
Based on the ARRC's work, we know that many legacy nonfinancial
corporate contracts referencing LIBOR have no workable fallback
language or no fallback language whatsoever and that many financial
contracts have fallbacks that would require parties to poll an unnamed
set of banks in an attempt to recreate LIBOR, which we believe would be
both burdensome and unsuccessful, or refer only to the last published
value of LIBOR, effectively converting what were intended to be
floating rate instruments to fixed-rate instruments.
The ARRC established several working groups to work with market
participants to develop more robust fallback language and publish
consensus recommendations on such language. ARRC working groups have
involved more than 300 different institutions, including lenders,
borrowers, investors, and consumer advocacy groups. Recognizing the
single importance of clarity and certainty with respect to fallbacks
for consumer contracts, the ARRC published a separate set of Guiding
Principles specifically designed for its work on consumer products. The
ARRC's work on fallback recommendations included numerous consultations
with market participants, each of which is publicly available. Many new
issuances now contain ARRC-recommended fallback language thanks to this
work. \2\
---------------------------------------------------------------------------
\2\ Following the work of each working group and the
consultations, the ARRC published recommended contractual fallback
language for floating rate notes, syndicated and bilateral loans,
securitizations, consumer adjustable rate mortgages, and student loans.
---------------------------------------------------------------------------
While developing recommended fallback language that could be
adopted in new contracts referencing LIBOR, the ARRC also recognized
that not all contracts can or will be amended by the time of LIBOR
cessation and that there will be a significant amount of legacy
contracts outstanding that will have no clear or effective reference
rate when the main tenors of U.S. dollar LIBOR cease or become no
longer representative immediately after June 30, 2023. To help to
address this, the ARRC developed and promoted legislation for contracts
governed by New York law to avoid the disruptions, market
uncertainties, and confusion that would otherwise occur when LIBOR
ends.
In March 2021, the New York State legislature passed legislation
supported by the ARRC that provided clear fallbacks to any contract
referencing LIBOR governed by New York law that otherwise has no
effective fallback language, either because it is has no fallback or
because it falls back to a LIBOR-based rate (or to a dealer poll to
determine a LIBOR rate). The State of Alabama subsequently passed
similar legislation. The passage of State legislation has been
extraordinarily important in helping to address the risks of the LIBOR
transition. In particular, many financial contracts are covered under
New York law. However, we know that many nonfinancial corporate
contracts, consumer loans, and securitizations are not covered by New
York or Alabama State law. While the ARRC is prepared to advocate for
similar legislation in other States, we cannot reasonably hope for
comparable legislative solutions in all 50 States and the District of
Columbia. Federal legislation can help to ensure an equal outcome for
all Americans.
The legislative proposal that I understand Members of this
Committee are working on and that a House committee passed earlier in
the year would help to ensure that equal outcome. As with the
legislation passed in New York and Alabama, the legislative proposal is
purposefully narrow, intended only to address contracts that could not
otherwise be changed. For contracts that already allow one party the
right to choose a new rate, a feature of most consumer contracts
referencing LIBOR, the proposed legislation does not alter the right of
the designated party to determine the successor rate, but it does
provide a safe harbor to encourage a choice based on SOFR, which has
had the strong support of consumer advocacy groups in addition to
lenders and investors. For contracts that do not grant a particular
party the right to name a successor rate to LIBOR and have no fallback
language or language that refers only to a poll of banks or some past
value of LIBOR, the proposal recognizes that a unique successor rate
must be named in order to avoid legal conflict and it names a successor
rate based on SOFR for that purpose, but again only for those contracts
that will not otherwise work in the absence of a legislative solution.
The proposed legislation has no impact for contacts that already
specify a non-LIBOR floating rate if LIBOR is unavailable, which is the
case for most legacy business loans. Parties may also opt out of the
legislation at any time.
As I have noted, the ARRC represents a very diverse set of
participants. We have worked by consensus to develop recommendations to
help ensure that the U.S. economy can successfully transition from
LIBOR. ARRC members have for some time strongly held the consensus view
that legislation addressing legacy LIBOR contracts is an important
component of the transition. We support your efforts to introduce
legislation in the Senate and, in conjunction with your counterparts in
the House, urge you to pass it as expeditiously as possible. We thank
you in advance for your consideration and stand ready to be a resource
in any way we can.
______
PREPARED STATEMENT OF ANDREW PIZOR
Staff Attorney, National Consumer Law Center
November 2, 2021
Chairman Brown, Senator Toomey, and Members of the Committee, thank
you for the opportunity to testify today on the importance of
protecting consumers when the benchmark LIBOR index comes to an end. I
have been an attorney with the National Consumer Law Center (NCLC) \1\
for 12 years. I provide my testimony here today on behalf of NCLC's
low-income clients.
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\1\ Since 1969, the nonprofit National Consumer Law Centerr
(NCLCr) has used its expertise in consumer law and energy policy to
work for consumer justice and economic security for low-income and
other disadvantaged people, including older adults, in the United
States. NCLC's expertise includes policy analysis and advocacy;
consumer law and energy publications; litigation; expert witness
services, and training and advice for advocates. NCLC works with
nonprofit and legal services organizations, private attorneys,
policymakers, and Federal and State Government and courts across the
Nation to stop exploitive practices, help financially stressed families
build and retain wealth, and advance economic fairness.
---------------------------------------------------------------------------
Introduction
My primary message here today is to encourage the Members of this
Committee, as well as the full Senate, to support H.R. 4616 but with a
more limited safe harbor, as I will explain today. This bill will
protect consumers and the credit industry from potentially devastating
consequences that could otherwise occur as the credit world transitions
away from the LIBOR index.
The LIBOR is currently written into more than a trillion dollars of
outstanding consumer mortgages, student loans, and other consumer
credit contracts. But it will cease to exist on June 30, 2023. \2\ When
that happens the companies that own and service those contracts must be
ready to adapt by substituting a new index for the LIBOR. If the
transition goes smoothly, few people will notice. But if they get it
wrong, the consequences could force millions of consumers into default
and lead to widespread litigation.
---------------------------------------------------------------------------
\2\ Fed. Reserve. Bd., CFPB, FDIC, et al., Joint statement on
Managing the LIBOR Transition at 1 (Oct. 20, 2021), available at
https://files.consumerfinance.gov/f/documents/cfpb--interagency-libor-
transition-statement-2021-10.pdf.
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Replacing the LIBOR Is a Complex Problem Fraught With Risk for Industry
and Consumers
The LIBOR is a benchmark interest rate compiled and maintained by
ICE, a private corporation based in London, U.K. According to ICE, the
LIBOR is ``designed to produce an average rate that is representative
of the rates at which large, leading internationally active banks with
access to the wholesale, unsecured funding market could fund themselves
in such market in particular currencies for certain tenors.'' \3\
Currently the U.S. Dollar version of the LIBOR is based on data
submitted voluntarily by sixteen contributor banks. \4\ Due to various
problems with the LIBOR, the U.K.'s Financial Conduct Authority has
announced that on December 31, 2023, ICE will stop publishing the
versions commonly used in consumer contracts. \5\
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\3\ ICE website, available at https://www.theice.com/iba/libor.
\4\ Id.
\5\ U.K. Financial Conduct Authority, FCA announcement on future
cessation and loss of representativeness of the LIBOR benchmarks (Mar.
3, 2021), available at https://www.fca.org.uk/publication/documents/
future-cessation-loss-representativeness-libor-benchmarks.pdf.
---------------------------------------------------------------------------
In relation to consumer transactions, the LIBOR is commonly used as
an index in adjustable rate home mortgages and student loans.
Typically, a loan contract will specify a starting interest rate that
will change at regular intervals over the life of the loan. The new
interest rate at each change is based on the current value of a
benchmark index named in the contract. The index value is then added to
a ``margin'' (a fixed number written into the contract), and that total
becomes the new interest rate on the contract. The servicer then
recalculates the monthly payment based on the new interest rate.
The typical contract also has a clause, known as ``fallback
language,'' that authorizes the noteholder to replace the index if the
original one becomes unavailable. The fallback language is central to
replacing the LIBOR. But it has never been used before, and the
standard language in almost all legacy contracts is too vague. For
example, until recently the fallback language in Fannie Mae and Freddie
Mac's contract forms said: ``If the Index is no longer available, the
Note Holder will choose a new index that is based upon comparable
information.'' Most non-GSE and student loan contracts use similar
language. A minority of contracts give the noteholder unlimited
discretion to select a replacement. Significantly, there is no accepted
understanding or definition of what is ``comparable.'' And the few
regulations addressing the selection of a replacement index only apply
to a small portion of the market. \6\
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\6\ See, e.g., Reg. Z, 12 CFR 1026.40(f)(3)(ii) (replacing index
for home equity line of credit); Reg. Z Off'l Interpretations, 12 CFR
1026.55(b)(2)-6 (replacing index for credit card).
---------------------------------------------------------------------------
The complexity of selecting a replacement is compounded in other
ways too. Most importantly, there is no alternative index that will
perfectly match the cost and movement of the LIBOR. As a result, any
replacement will entail some compromises and will risk imposing a cost
on one party to the contract. Nobody can predict future interest rates,
so--even if the transition is conducted fairly--it is difficult to
predict who will bear the burden and how big a burden that will be.
A related problem is that some contracts may require other
adjustments to incorporate the new index. These adjustments are
generically called ``conforming changes,'' because they are intended to
bring the contract into conformity with the replacement index. One of
the most significant conforming changes will be to the margin. Because
the new index will almost certainly have a different starting and
average rate, the margin will need to be changed to result in a
``comparable'' contract rate. Some contracts allow the noteholder to
make this change but many do not. \7\ Other adjustments may be
necessary too. This is another source of risk and controversy because
there is no consensus on what conforming changes are appropriate or
whether the fallback language authorizes noteholders to make them.
---------------------------------------------------------------------------
\7\ Regulation Z specifically allows creditors to change the
margin for home equity lines of credit. 12 CFR 1026.40(f)(3)(ii). But
there is no equivalent provision for closed-end mortgages.
---------------------------------------------------------------------------
The crux of the risk for consumers and industry participants is
that making the wrong decisions will lead to an unreasonable transfer
of value. One party to the contract will unfairly profit and the
counterparty will be harmed.
As long-time representatives of consumers, we are very familiar
with the devastating consequences of predatory lending. This underlies
our concern that some noteholders may abuse or mismanage their broad
discretion in a way that gouges consumers. There are a number of ways
this might happen. Unscrupulous, or even just sloppy, lenders or
mortgage loan servicers could--
use a replacement index that is too volatile or that trends
at a higher rate than the LIBOR;
employ a different margin that is too high and results in a
windfall for the noteholder;
make other inappropriate and harmful changes to the
contract under the guise of ``conforming changes,'' such as by
changing the method by which payments are calculated, or even
changing the due date for payments;
fail to replace the LIBOR altogether, leaving the loan
stuck at the last LIBOR and locking in a higher-than-market
rate; or
botch the mechanics of replacing the LIBOR, such as by
using a different date to measure the applicable index in a way
that unfairly benefits the lender.
Consumers have no control over what happens in this process and
contracts provide them with no say in which index the noteholder
selects. Their only recourse will be to complain or initiate
litigation.
The Credit Industry Should Adopt the ARRC's Recommended Replacement:
The SOFR
For the past several years, a committee of industry participants,
known as the Alternative Reference Rate Committee (ARRC) \8\ has worked
to prepare for this transition. NCLC and other consumer groups have
participated in these deliberations. The ARRC has developed a set of
well-vetted plans and recommendations that will protect consumers as
well as industry. Unfortunately, their recommendations are non-binding.
And, as the situation stands today, too few industry participants have
committed to follow them. We believe fear of litigation is a major
reason for the recalcitrance. They are worried that whatever index they
choose, someone will sue them: either consumers, whose payments may
increase, or investors, who may believe they are losing money.
---------------------------------------------------------------------------
\8\ ``The ARRC is a group of private-market participants convened
to help ensure a successful transition from USD LIBOR to a more robust
reference rate, its recommended alternative, the Secured Overnight
Financing Rate (SOFR). It is comprised of a diverse set of private-
sector entities, each with an important presence in markets affected by
USD LIBOR, and a wide array of official-sector entities, including
banking and financial sector regulators, as ex officio members.'' Fed.
Reserve Bank of N.Y. website, https://www.newyorkfed.org/arrc/about.
---------------------------------------------------------------------------
The refusal of a significant part of the credit industry to agree
to abide by the recommendations of the ARRC endangers consumers. This
refusal also endangers the stability of the economy in the United
States.
Replacing the index is the primary challenge of the LIBOR
transition. Fortunately, the ARRC has identified the most suitable
replacement index: the Secured Overnight Refinancing Rate (SOFR). The
technical aspects of why the SOFR is appropriate are beyond the scope
of NCLC's discussion today, but there is no doubt that the ARRC and the
Federal Reserve Bank of New York have sufficiently vetted the SOFR. As
a result of their work, it has become clear that the SOFR, when
implemented as recommended by the ARRC, \9\ will minimize any value
transfer caused by the end of LIBOR. It is the best option for both
industry and consumers.
---------------------------------------------------------------------------
\9\ Including the recommended spread-adjustments.
---------------------------------------------------------------------------
Congress Should Mandate Use of the SOFR or Offer a Safe Harbor for
Voluntary Use
Despite the ARRC's recommendations, too few industry participants
have announced that they will adopt the SOFR for legacy consumer
contracts. Delaying this decision to the last minute will increase the
risk of implementation errors and the potential for broader economic
instability. NCLC and other consumer advocates have urged Federal
regulators to adopt strong regulations that will compel industry to
adopt the ARRC's recommendations, but they have not done so. States
have limited ability to adequately address the problem because of
Federal bank law preemption. However, leaving the transition entirely
to the market poses too great a risk to the financial markets, to bank
safety and soundness, and to millions of individual homeowners, student
loan borrowers, and their families.
The best solution is for Congress to require noteholders to replace
the LIBOR with the SOFR in all consumer contracts. But this proposal
has been rejected by the credit industry, so we have agreed with
industry trade groups on a suitable compromise. As an alternative to a
mandate, Congress should create a safe harbor from litigation for
noteholders that voluntarily adopt the ARRC's recommended benchmark
replacement index.
The House of Representatives is already considering such a bill,
H.R. 4616, the Adjustable Interest Rate (LIBOR) Act of 2021. We support
the ideas behind H.R. 4616 but only with changes to the safe harbor
that will prevent abuse.
While consumer advocates generally oppose safe harbors from
litigation, we believe a narrowly tailored one is appropriate for this
unique situation. A safe harbor provides a company with immunity from
lawsuits by anyone claiming to have been harmed by conduct within the
scope of the safe harbor. Safe harbor laws are often too broad, poorly
drafted, and more likely to protect wrongdoers than to accomplish
anything positive for society. But in this case, we have negotiated a
narrowly focused safe harbor law that--while not our first choice--will
avoid the greater harm we expect if noteholders adopt indices other
than the SOFR.
Specifically, we recommend that Congress adopt a safe harbor for
consumer contracts that is limited to liability for:
the selection or use of the SOFR recommended by the ARRC
and Federal Reserve Board; and
the implementation of necessary conforming changes.
While we support the concept of a safe harbor embodied in H.R.
4616, the language of the bill is currently too broad. In its current
form, the safe harbor would also include consumer claims arising out of
the determination and performance of conforming changes. We are
concerned that disreputable actors could harm consumers by taking an
overly broad interpretation of what conforming changes are necessary to
implement a new index. If that happens, the current version of H.R.
4616 could immunize some of the misconduct I describe in section II,
supra, of my testimony.
Based on our experience with consumer contracts, we believe that
very few--if any--conforming changes will be needed. And those that may
be needed will be so basic and ministerial that there is no reason to
incentivize them with the offer of a safe harbor. Therefore, we have
agreed with industry representatives that the safe harbor for consumer
contracts will not include the determination of what conforming changes
are necessary or the performance of conforming changes. Instead, the
definition of ``conforming changes'' will be determined by the Federal
Reserve Board (FRB). Only those changes will be within the scope of the
safe harbor. Appendix A [Ed.: Not included] to my testimony is a
document showing the changes that we and industry representatives
recommend making to H.R. 4616. This document has already been shared
with House and Senate staff.
In the statutory language that we have proposed, the selection of
the replacement index refers only to the question of whether to use one
index or another. If a noteholder selects the appropriate SOFR, that
decision will be protected by the safe harbor. Selecting any other
index will be outside the safe harbor. This will encourage noteholders
to follow the ARRC and FRB's recommendation, but will not require them
to do so.
Use of the replacement index refers only to routine performance of
the contract once the new index has been substituted for the LIBOR.
This primarily refers to the regular rate and payment changes called
for by the loan contract. So, for example, if a borrower has an ARM
that calls for annual rate changes, the safe harbor would cover
calculation of the new interest rate and loan payment each year based
on the SOFR. Neither a consumer nor an investor could claim that they
were harmed because the new payment was based on the SOFR. But if the
servicer makes a mistake in doing so, for example by using the SOFR
from the wrong date, making a typo when entering the value into the
computer, or miscalculating the new payment, those mistakes would not
be protected by the safe harbor and the consumer would retain the right
to seek appropriate relief.
Conclusion
NCLC represents the interests of millions of low-income consumers
who will be directly affected by the end of the LIBOR. If industry
participants replace the LIBOR with an inappropriate index; if they
mismanage the transition; or if they take advantage of the opportunity
to make other changes that cost consumers, many people will be harmed.
That risk can only be avoided if Congress acts by passing
legislation to ensure that industry participants adopt the most
appropriate replacement for the LIBOR--the Secured Overnight
Refinancing Rate (SOFR). After extensive discussions, we have agreed
with some of the most important industry trade groups that H.R. 4616 is
the best vehicle for doing so--but only if it is amended to narrowly
tailor the safe harbor in a way that will protect consumers.
Recommendation: The Senate should pass a bill modeled on H.R. 4616
but with a more limited safe harbor connected to a narrow definition of
``conforming changes'' to be provided by the Federal Reserve Board.
I want to conclude by praising industry, the Members of this
Committee, and the House committee for working together to find a
solution that is good for everyone. Thank you for considering the views
of consumers. I am happy to answer any questions.
______
PREPARED STATEMENT OF J. CHRISTOPHER GIANCARLO
Senior Counsel, Willkie Farr & Gallagher LLP, and Former Chairman, U.S.
Commodity Futures Trading Commission
November 2, 2021
Introduction
Thank you, Chairman Brown, Ranking Member Toomey, and Committee
Members. It is an honor to appear before this Committee once again.
I am Chris Giancarlo, Senior Counsel at the law firm of Willkie
Farr & Gallagher.
I had the honor to serve our country as the thirteenth Chairman of
the U.S. Commodity Futures Trading Commission (CFTC), a Federal agency
that has led and continues to lead the transition away from the LIBOR
interest rate benchmark, the subject of today's hearing. I am also an
independent director of the American Financial Exchange.
I commend Chairman Brown and Ranking Member Toomey for holding this
hearing. Congressional leadership on this issue is important to ensure
banks and all financial institutions of every size, shape and location
understand that LIBOR will be replaced and will be replaced soon.
Over 4 years ago, on the very day that the U.S. Senate unanimously
confirmed my nomination as CFTC Chairman, Federal Reserve Chairman
Jerome Powell and I published an opinion piece in the Wall Street
Journal, entitled ``How to Fix Libor Pains''. In it, we wrote:
. . . the time has come for market participants and regulators
to work together on a plan for dealing with existing Libor-
based contracts maturing after 2021. This plan must also
address how to expand adoption of the broad Treasury repo rate
into a wider array of products that rely on a benchmark . . .
There is time for this transition to be done thoughtfully. Our
agencies are prepared to help ensure that it is done
cooperatively and smoothly.
I was committed then and remain committed today to do everything
possible to assist the transition away from LIBOR. The transition is
here and now. Beginning in January 2022, no new capital markets or
lending contracts can be based on LIBOR.
Beginning in June 2023, all existing LIBOR contracts must be
replaced with a LIBOR replacement. This hearing is an important step in
getting it done.
The Shortcomings of LIBOR
As you well know, the London Interbank Offered Rate, or LIBOR,
plays an important role in American finance. The credit cards,
floating-rate mortgages and car loans of many of our fellow American
citizens and even the day-to-day funding for the companies where they
work are all influenced by LIBOR. This arcane interest rate is meant to
reflect the rate that large banks must pay to borrow short term. It is
used to calculate the rate of interest on more than half of American
home mortgages. LIBOR is cited in financial contracts setting trillions
of dollar-denominated loans, securitizations, and derivatives.
I have extensive experience, both as a market regulator and
business executive, with financial benchmarks and, most particularly,
with LIBOR. Before entering public service, I served as the Executive
Vice President of GFI Group, a leading trading platform and technology
vendor to global markets for OTC swaps and other financial derivatives,
many of which refer to LIBOR. As former Chairman of the CFTC, I am
familiar with the critical importance of reference benchmarks for the
sound functioning of U.S. markets for risk mitigation and reliable
price discovery.
The shortcomings of LIBOR first came to light during the 2008
financial crisis with reports of manipulation of the rates used to
calculate it. My former agency, the Commodity Futures Trading
Commission, was a leader in investigating and sanctioning a number of
major banks for benchmark manipulation. Prosecution of many of those
cases proceeded determinedly under my administration.
LIBOR is calculated daily from the quoted rates that a panel of a
few large banks provide to ICE Benchmark Administration, an independent
subsidiary of the Atlantabased firm Intercontinental Exchange. The
quotes represent the rates at which the banks estimate they would be
able to borrow in short-term money markets. Yet, apart from overnight
transactions, the large banks providing those submissions no longer
borrow much in those markets. There are very few actual loan
transactions on which these quoted rates are based. In essence, a few
large banks are contributing a daily judgment about something they no
longer do.
As a result, LIBOR suffers from two fatal flaws: shallowness of
liquidity because of thin trading volume and narrowness of liquidity
because of its reliance on only a handful of rate setters. When it
comes to the potential for manipulation, the second shortcoming may be
worse than the first.
Back in 2017 during my CFTC service, the U.K.'s Financial Conduct
Authority, the agency primarily responsible for regulating LIBOR,
called for a worldwide transition away from LIBOR because of these very
shortcomings and the risk they present. Here in the United States, we
welcomed this move. The CFTC's Market Risk Advisory Committee under the
keen leadership of Commissioner Russ Benham, now Acting Chair and the
President's nominee for CFTC Chairman, led agency efforts during my
Administration and continues to lead efforts to spur the transition
away from LIBOR.
LIBOR Alternatives: SOFR
At the same time in 2017 as the CFTC was prosecuting LIBOR
manipulators and considering its risk to financial markets, the Federal
Reserve Board convened a group of institutional participants that
broker and clear LIBOR transactions to form the Alternative Reference
Rates Committee, known as ARRC. It is a pleasure to appear today
alongside Tom Wipf of Morgan Stanley, who chairs ARRC. Tom has worked
tirelessly on these issues and has ably led the ARRC Committee. Under
his leadership, the ARRC is focused on ensuring a smooth transition
away from LIBOR for existing and new contracts.
Following an extensive consultation, the ARRC committee recommended
replacing LIBOR with a rate derived from short-term loans that are
backed by a range of Treasury securities as collateral (known as
Treasury repurchase agreements or ``Repo''). The Treasury Repo market
is a fully collateralized financing market that enables the largest
institutions to lend and borrow amongst each other, typically on a very
short term basis. This interest rate derived from this market is a
measure of practically risk-free borrowing because U.S. Treasury
securities serve as collateral. With such risk-free collateral, the
interest rate does not reflect the credit quality of the market
participants, but rather the status of U.S. Treasury securities as the
world's safest investment.
Unlike LIBOR, SOFR is built upon actual market transactions of
roughly $800 billion in daily activity. That provides much greater
depth of trading liquidity than LIBOR. This feature directly addresses
a key weakness of LIBOR: shallowness of trading liquidity.
The Treasury Repo market is not only critical to the world's
largest financial institutions, but it is also critical for ensuring
liquidity in the U.S. Treasury debt market.
The Federal Reserve Bank of New York is deeply involved in the Repo
market in its role of managing Fed Open Market Operations in
implementing Federal Reserve monetary policy. Widespread adoption of
the SOFR benchmark is supportive of the U.S. Treasury debt market.
SOFR is complementary to the cost of funding for many of America's
largest banks that are primary dealers of Treasury securities and can
use them as collateral for funding. Combined, these institutions have
over eleven trillion dollars in assets. SOFR is therefore a highly
appropriate LIBOR replacement for a broad range of financial
institutions, especially primary dealers of U.S. Treasuries and other
large firms that participate in that essential marketplace. I am very
supportive of widespread adoption of SOFR as a well-constructed and
durable, risk free interest rate benchmark.
LIBOR Alternatives: AMERIBOR
Away from Wall Street, America has almost 5,000 community and
regional banks and lending institutions with another $11 trillion in
assets. These institutions lend to the real economy of America's small
to medium-sized businesses, including manufacturers, equipment dealers,
service providers, agriculture producers, and home builders that are
America's job creators. These community lenders generally do not hold
U.S. Treasury securities and other risk free collateral. Rather, they
lend against relatively illiquid collateral of plant and equipment
liens, property mortgages, auto leases, and personal guarantees. In
effect, these lenders take real risk. They are highly credit sensitive.
Over my 5 years at the CFTC, I traveled over half the country to
meet with thousands of Americans who depend on CFTC-regulated markets
to hedge the prices of agriculture, mineral, or energy commodities they
produce. In the course of those travels, I descended 900 feet
underground in a Kentucky coal mine, climbed 90 feet in the air on a
North Dakota natural gas rig and flew 900 feet in the air in a Arkansas
crop duster. I walked factory floors in Illinois, pecan farms in
Georgia, grain elevators in Montana, feed lots in Kansas, and power
plants in Ohio. Almost all of the small and medium-sized businesses I
met were supported by America's community, State, and regional banks. I
know how much those community banks, in turn, need support from
Washington.
Among other roles I have assumed since completing my service at the
CFTC, I serve as an independent member of the Board of Directors of the
American Financial Exchange (AFX). AFX was founded in 2015 by Dr.
Richard Sandor, American economist and entrepreneur, who pioneered
interest rate futures and created the world's first trading exchange
for the reduction and trading of greenhouse gas emissions, for which he
is known as, ``The Father of Carbon Trading.'' My professional
relationship with Dr. Sandor began almost two decades ago in the
private sector. Upon completion of my Government service, I was
delighted when Dr. Sandor invited me to serve as an independent board
member of AFX.
AFX is an electronic marketplace where banks in the U.S. can
directly lend and borrow short term funds to one another on an
unsecured, credit sensitive basis. AFX has over 225 members as well as
over 1,000 correspondent American banks. The assets of AFX members
exceeds $5.3 trillion dollars. Measured by both the number of U.S.
banks and aggregate bank assets, AFX members constitute about 25
percent of America's banks and community lenders, including the 5th,
6th, and 7th largest banks in the United States.
AFX member banks are in all 50 U.S. States, including States
represented by every Member of this Committee. AFX members include some
of America's most respected local and regional banks as U.S. Bank,
Keybank, Zions, First Financial, Citizens Trust, Brookline, East-West,
Abacus Federal Savings, Cambridge Savings, Cape Cod Five Cents Savings,
Cathay Bank, Customers Bank, Dime Community, Fulton Bank, Glacier Bank,
Hope Bank, Asian Bank, Dollar Bank and Signature, ServisFirst, Unity,
and Truist Banks.
AFX members are highly representative of America's community,
minority-owned and regional banks. That includes a significant share of
America's critical minority-owned depository institutions that play a
vital role in serving traditionally underserved communities, often
lending to businesses and entrepreneurs with minimal collateral. By
asset size, AFX members today represent about forty (40 percent)
percent of U.S. Minority Depository Institutions (MDIs), including some
of America's most innovative African-American, Asian-American, Hispanic
and Native-American banks. The National Bankers Association, the
leading minority-owned bank trade association in America, has endorsed
AFX's interest benchmark as an approved rate to be used for loan
documentation for its members.
AFX was conceived and founded well before the decision to
transition away from LIBOR. AFX was not created to benefit from LIBOR's
demise. Like all good ideas, AFX was created to address a commercial
need: to provide America's community and regional banks with a way to
lend to and borrow from each another in a regulated, transparent market
on a peer-to-peer basis. AFX offers America's community and regional
banks a complementary alternative to their traditional source of
funding from large money center banks on Wall Street.
Every business day, tens of billions of dollars of loans are lent
and borrowed by hundreds of participants in the AFX institutional
marketplace. The marketplace is electronic, transparent and self-
regulated under the scope of the CFTC's comprehensive regulatory
framework. It is compliant with standards developed by the
International Organization of Securities Commissions (IOSCO) for
appropriate LIBOR benchmark replacements. The interest rate at which
AFX members independently agree to borrow and lend are tracked and
compiled into a series of benchmarks that include the
AMERIBOR' Term-30 index. The index is published nightly and
displayed on almost all financial data feeds like Reuters and Bloomberg
and financial broadcast media.
These AMERIBOR benchmarks are complementary to the cost of funding
for thousands of AFX members and correspondent firms whose lending
activities to the real economy is highly credit sensitive and supported
by relatively illiquid, physical collateral, and personal guarantees.
For these institutions, AMERIBOR best represents their cost and risk of
funding. As a result, AMERIBOR benchmarks are favored by the thousands
of AFX members and correspondent firms as an interest rate benchmark
for commercial lending contracts. For this reason, I support adoption
of AMERIBOR by institutional lenders who require a well-constructed and
durable, credit sensitive interest rate benchmark.
Market Diversity and Durability
It will not surprise the Committee to hear that at my core I
believe in open and competitive U.S. markets. But my comments today are
frankly less about the need for competition in the LIBOR replacement
market and more about choice. SOFR and AMERIBOR should not be viewed as
competitive but as complementary. They are different. SOFR is a risk-
free rate and AMERIBOR is a credit sensitive rate. They are
alternatives for different needs and different sectors of the
marketplace.
From my service at the CFTC, I know that most of America's
important trading markets feature a diverse set of pricing benchmarks
serving different needs. In our grain futures markets there are
multiple pricing benchmarks, including Chicago soft red winter wheat,
Kansas City hard red winter wheat, and Minneapolis hard red spring
wheat. The different benchmarks serve to establish the cost of
different varieties of wheat used in different bread products. (Pizza
dough is made from different wheat than breakfast cereal). In oil
markets there is West Texas Intermediate and Brent crude oil, again
setting distinct prices for different fuel products, like domestic auto
gas or industrial diesel. Of course, in our equity markets, there are
multiple benchmarks like the Dow Jones Industrials, the S&P 500, and
the Russell 2000 to measure the different performance of large cap and
small cap companies. Such existence of a variety of specifically
designed benchmarks allows market participants to engage in investment
activities that are specifically crafted to their investment needs
rather than a ``one-size-fits-all'' approach. Choice of benchmark is
one reason why U.S. futures and equity markets are the world's deepest,
most liquid, and most attractive to global capital.
Strangely, one U.S. market that has not traditionally enjoyed a
similar choice of benchmark is bank lending, where LIBOR has been
dominant for decades. In fact, the ubiquity of LIBOR and long absence
of competing, commercially derived interest rate benchmarks is one of
the reasons why the demise of LIBOR presents a potential crisis today.
Lack of choice of interest rate benchmark is itself a systemic risk.
Nassim Nicholas Taleb, the well-known market observer who coined
the phrase ``Black Swan'' has written about the increased fragility of
today's top-down designed, overly complicated economic systems. \1\ He
warns that concentration in complex systems such as financial markets
makes them more vulnerable, not less to cascading runaway chains of
reactions and ultimately fragile in the face of outsized crisis events.
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\1\ See, generally, Nassim Nicholas Taleb, ``Antifragile: Things
That Gain From Disorder'', (Random House) 2012.
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He posits that the opposite of such fragility is ``antifragile,''
meaning systems that become stronger when subject to stress, the way a
human body becomes immune to a disease through exposure or inoculation.
He explains that financial markets that are allowed to grow organically
through gain and loss with plenty of redundancy and choice best
resemble biological organisms that adapt and, indeed, thrive.
The United States banking industry is quite unique and
extraordinary. On the one hand, its large money center and Wall Street
investment banks lead the world in sophisticated global trading,
investment banking, and large project finance. On the other hand,
America's community and regional banks spread out across the urban,
suburban, and rural landscape finance the everyday needs of America's
consumers, small and medium-sized businesses, and domestic job
creators.
A banking industry that is so varied, so complex and so essential
to the American economy needs the diversity and durability that comes
from choice in interest rate benchmark. A one-size-fits-all response to
the demise of LIBOR would be a source of systemic risk to the U.S.
economy. As we rightfully move away from LIBOR, we should make clear
that lending institutions--be they money center banks or local,
regional or MDI banks--should have the flexibility to choose among
IOSCO compliant benchmark alternatives that best meet both their
lending activity and their customers' needs.
Federal Legislation
There is a clear consensus, that I share, that Federal legislation
is necessary to ensure smooth and efficient transition away from LIBOR.
As Treasury Secretary Janet Yellen stated in her testimony before the
House Financial Services Committee earlier this year, legislation is
necessary for tough legacy contracts that do not specify a workable
fallback rate making it not feasible for private-sector actors to
modify on their own. \2\ Legal certainty is absolutely critical to
ensuring that institutions with existing tough legacy contracts can
replace their LIBOR benchmark before the end of June 2023, the
termination date for all existing LIBOR contracts.
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\2\ Oversight of the Treasury Department's and Federal Reserve's
Pandemic Response. U.S. House Financial Services Committee (March 23,
2021), https://www.youtube.com/watch?v=AQsLydo6mJI&t=3488s at 58:44.
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There is legislation moving through the House of Representatives,
H.R. 4616, the Adjustable Interest Rate (Libor) Act of 2021, that would
provide much needed legal certainty. The legislation makes clear that
all LIBOR contracts must be converted to an alternative benchmark
before June 30, 2023. Furthermore, if the contract does not provide
clarity how an alternative benchmark can be reassigned, the institution
would have legal certainty if LIBOR is replaced with SOFR. Also, as it
relates to ``new'' contracts, the legislation, in the ``Findings''
section, provides helpful language that institutions entering into new
contracts will have choice of which benchmark they can utilize. AFX
supported this legislation when it was before the House Financial
Services Committee where it was ordered to be reported to the full
House.
Enactment of legislation providing legal certainty for the
conversion of those tough legacy contracts is absolutely critical. I
would also urge the Committee to consider providing stronger language
ensuring that, as institutions are entering into new contracts, they
have the clear ability to choose among properly qualified benchmark
replacements. Qualifying factors could include, for example, benchmarks
meeting the IOSCO standards and benchmarks that are built around
market-based trading and fully transparent price discovery.
Conclusion
LIBOR has been the world's most used interest rate benchmark. A
such, the transition away from LIBOR has been, and continues to be, a
long journey. In less than 2 months LIBOR will cease as the benchmark
for new contracts and in less than 20 months all legacy LIBOR contracts
must be replaced with an alternative benchmark. SOFR and Ameribor and,
no doubt others, will help us put LIBOR in the rear view mirror. But
this Committee and this Congress can help facilitate that smooth
transition by providing legal certainty as it relates to tough legacy
contracts and responsible choice for new contracts.
If I can leave you with one thought, it is that there is simply no
one-size-fits-all lending benchmark for an economy as unique and
diverse as the United States. Having choice among multiple, properly
qualified benchmarks not only facilitates the transition away from
LIBOR, but it also enhances efficiency, reduces systemic risk and
encourages economic growth as we progress through the transition
process. Both SOFR and AMERIBOR represent the kind of home grown
American ingenuity and innovation, along with a sound regulatory
infrastructure, that has helped make U.S. markets the deepest, most
liquid and most efficient markets in the world.
Thank you and I look forward to your questions on this important
matter.
______
PREPARED STATEMENT OF MICHAEL BRIGHT
Chief Executive Officer, Structured Finance Association
November 2, 2021
Introduction and Background
Chairman Brown, Ranking Member Toomey, and other Members of the
Committee, my name is Michael Bright, CEO of the Structured Finance
Association, or ``SFA.'' On behalf of the member companies of SFA, I
thank you for inviting me to testify. I also thank you for your focus
on finalizing the transition away from LIBOR for millions of consumers
and investors with loans or savings tethered to these rates.
The Structured Finance Association is a consensus-driven trade
association with over 370 institutional members representing the entire
value chain of the securitization market. By facilitating the issuance
and investing of loans and securities, this market provides trillions
of dollars of capital to consumers and businesses in communities across
the country. Our members facilitate credit and capital formation across
a wide breadth of asset types and industries, including auto loans,
mortgage loans, student loans, commercial real estate, business loans,
among others.
SFA members include issuers and investors, data and analytic firms,
law firms, servicers, accounting firms, and trustees. Importantly, many
of our investor members are fiduciaries to their customers. Unlike some
trade associations, before we take any advocacy position our governance
requires us to achieve consensus by agreement rather than majority
vote, ensuring the perspectives of all our diverse membership are
included. This diversity is our strength, as it builds healthy tension
in arriving at our consensus positions. Because of this, we are
methodical and thoughtful as we analyze the pros and cons of
legislative and regulatory proposals, as well as market dynamics,
before we reach a mutually acceptable position that represents the
entirety of the capital markets.
Formed in 2013, the Structured Finance Association's stated mission
is: ``To help its members and public policy makers grow credit
availability and the real economy in a responsible manner.'' \1\ There
are very few issues that touch on this core mission as much as the work
we are doing to help responsibly transition away from U.S. dollar (USD)
LIBOR. Further, this issue is one that has unified all participants in
our membership--from issuer to investor, and everyone in between--on
the need for Federal legislation to help ensure a final transition
takes place smoothly and efficiently.
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\1\ https://structuredfinance.org/about-us/
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Absent Federal legislation to provide a consistent and fair
solution as well as a safe harbor for certain so called ``tough
legacy'' contracts--that is, USD LIBOR contracts lacking clear fallback
language--retirees and savers will be forced to foot the bill for
billions if not tens of billions of dollars in legal costs. This will
occur as trustees would need to seek court guidance on which
replacement rates to select and how to incorporate that rate into the
existing contract. The absence of Federal legislation for these
contracts also opens the possibility that consumers could be left in an
uncertain position under contracts that fail to provide a fallback
directive upon LIBOR's cessation. With legislation, however, there are
critical incentives for lenders to provide consistent treatment to all
consumers. I will outline in detail in my written testimony below how
this dynamic has come about, and why, as to this remaining pool of
legacy contracts, the market is unable to resolve this issue without
enormous litigation expense.
Securitization and structured finance are critical elements of
today's economy. The pooling of loans into a security, coupled with the
separation of highest credit and prepayment risks from lower prepayment
and credit risks, allow for efficient matching of borrower and investor
preferences. This segmentation of risks lowers the cost of credit to
the consumers and businesses that the capital markets fund while
providing more tailored investment options to investors with varying
risk preferences. Our members know that, when done properly, this work
facilitates economic growth and capital formation across all
communities.
Background on LIBOR Transition to Date
Let me first make abundantly clear that many of SFA's member
companies were impacted by the LIBOR scandal. In particular, SFA
investor members need to assured that this never happens again. All of
our members must know that, going forward, contracts based on a
floating rate index can rely on the integrity of that index. For these
reasons, SFA has been an active member in the Federal Reserve's
Alternative References Rate Committee, or ``ARRC'', a group whose
purpose includes ensuring an orderly transition away from LIBOR.
Extensive progress has been made on this gigantic financial
undertaking. Out of over $200 trillion of U.S. dollar-based contracts
that are tied to LIBOR, nearly all have managed to put in place a plan
for transition to a new rate. This was achieved across banking and
financial sector regulators, market participants and consumer groups.
As there wasn't a natural replacement rate for U.S. dollar LIBOR in
existence, the transition started with the critical task of identifying
and developing trusted and widely adopted alternative reference rates
and ensuring those rates won't present the same flaws as LIBOR or other
systemic deficiencies. As the alternative replacement rates were not
previously published, groundbreaking work was launched to build market
understanding, acceptance, and liquidity in these alternative rates
required by borrowers, lenders, and investors.
With alternative rates available and the liquidity and market
acceptance of those rates steadily building, attention quickly turned
to ensuring that all new contracts that still referenced LIBOR
incorporated so called ``fallback'' language. This fallback language is
agreed to by all contract parties and clearly specifies what interest
rate would be used in the event that LIBOR is unavailable or ceases to
exist. In parallel to incorporating fallback language in new contracts,
work began in large scale by lenders, borrowers and investors to amend
millions of existing LIBOR contracts that mature after the expected
cessation date of LIBOR. All this effort, significantly supported and
helped by a widespread number of market participants, consumer groups,
and regulators within product-specific working groups of the ARRC, has
reduced the USD LIBOR exposure that will remain after the June 2023
LIBOR cessation date from over $200 trillion to an estimated $16
trillion. \2\
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\2\ This is a best guess estimate taken by surveying our member
firms. This number includes many types of contracts, ranging from
floating rate mortgage to student loans, loans to businesses, and
embedded interest rate swaps in contracts.
---------------------------------------------------------------------------
Meanwhile, market participants have continued to work to build
liquidity and transparency in the alternative reference rates, which
allow for the hedging of interest rate risk in a liquid capital market.
That hedging allows borrowers to access products like the fully
prepayable fixed rate mortgage, or to issue corporate debt that matches
a company's assets and cash flows.
Finally, new security issuance continues to increase in all product
types. Building off the liquidity of a secondary market for hedging,
the amount non-LIBOR floating rate contracts continues to increase each
month.
``Tough Legacy'' Contracts, and Other Remaining Challenges
Even with this well-organized multiyear effort, these estimated $16
trillion contracts have no realistic means to be renegotiated and
amended. While small compared to the overall size of outstanding LIBOR
contracts, this is still a large sum, posing an enormous risk to the
financial system and the underlying borrowers, investors and banks if
not dealt with properly. These so-called ``tough legacy'' contracts
include mortgages, student loans, business loans, and capital market
transactions that finance and hedge these legacy LIBOR-based contracts,
and therefore impact a broad range of American households and
businesses.
The simplest explanation for these contracts is that, after more
than 30 years of publication and use in over 98 percent of U.S. dollar
floating rate contracts, most contracts that were entered into prior to
the announcement of LIBOR's end simply did not contemplate the
permanent cessation of such a ubiquitous rate. While in hindsight today
it may seem obvious that LIBOR could come and go, for many decades this
simply and unfortunately was not the case.
These tough legacy contracts often have very high legal and
operational hurdles to amending their terms, not the least of which is
identifying, contacting, and negotiating with the large number of
contractual parties who must consent to any such amendment. For
instance, in all widely distributed bonds there are upwards of hundreds
of bondholders who must be involved in the negotiation--and most often
unanimous consent--that is required to change the interest rate of the
bond. Moreover, even in normal market circumstances, due to investor
privacy constraints and operational hurdles, identifying and
communicating with bondholders in certain products is very challenging,
if not impossible. On the massive scale required by the LIBOR
transition, it is viewed as fruitless.
Finally, in the likely absence of meeting these impractical
hurdles, the third-party trustees, who administer certain contractual
provisions in the structured finance market, would need to seek
direction through judicial proceedings to navigate the transition to a
replacement rate. This is what will happen in the absence of safe
harbor legislation, and--as per the contracts--most of the legal costs
for structured finance bonds will be borne by the underlying investors
and savers.
Recognizing the significant economic, operational and legal risks
of these $16 trillion contracts, for the past few years SFA investors,
bond issuers, lenders, trustees, paying agents and servicers members
have worked extensively with each other, and with consumer groups,
regulators and other sector participants, to evaluate potential
solutions. Early in the process of managing away from LIBOR, many of
these stakeholders expressed concern about the use of legislative
action that would affect previously agreed contractual matters.
However, after lengthy deliberation and debate, a consensus position
across the entire market emerged that the cessation of this critically
important benchmark rate presents such a unique challenge that other
alternatives examined were inoperable, could lead to inequitable
outcomes for investors or consumers, presented extensive and costly
litigation risk, or all the above. As such, firms that would under
normal circumstances find legislation to amend contracts anathema, are
now strong advocates for Federal legislation to ensure a smooth and
fair transition.
Principles of a Legislative Solution
Again, after much discussion amongst our members and stakeholders,
SFA members found that legislation is not only the best option, but the
only viable option to safely, fairly, and equitably transition tough
legacy contracts. Moreover, it became clear that, absent congressional
action, the remaining challenges of the LIBOR transition will create a
great deal of confusion for borrowers and investors while further
degrading the value of these fixed-income investments for savers,
pensioners, and retirees.
With that as background, SFA market participants identified five
key principles of a legislative approach:
Minimize any value transfer among the contractual parties
Use a single, consistent replacement benchmark for all
similar LIBOR contracts based upon a liquid, robust replacement
benchmark
Minimize litigation risk through a comprehensive but narrow
safe harbor that provides adequate operational flexibility for
billing and paying agents to implement the use of the new
replacement benchmark
Narrowly scope legislation to facilitate the transition
away from LIBOR without impacting investor, consumer, or other
counterparty rights and protections
Do not impact contracts that already have a sufficient
replacement mechanism unless contract parties opt-in on their
own
To be clear, SFA believes that legislation should in no way
prohibit parties from agreeing together on a different replacement
rate, if they so choose. Legislation should pay careful attention to
all Constitutional rights embedded in contracts, and for this reason
SFA has spent considerable time working with experts in this area of
the law. And legislation should in no way contribute to wealth transfer
between parties. These all represent important boundary conditions on
how any law would work, and therefore discussions over every provision
of proposed legislation have taken thousands of hours of work.
With these principles in mind, SFA is strongly supportive of the
prospective Federal legislation that recently passed out of the House
Financial Services Committee. We also know that legislation may undergo
additional technical edits, and we know that the Senate is working on
similar legislation with similar goals. With the principles enumerated
above, we continue to be appreciative of all this legislative work. On
behalf of the entire membership of SFA, I specifically want to thank
Senators Tester and Tillis for the leadership they are providing on
this issue.
As you likely know, recently, both Chairman Powell and Secretary
Yellen also expressed their support for Federal legislation. On
February 24, 2021, Jay Powell, Chair of the Federal Reserve, called
Federal legislation the ``best solution'' to address outstanding legacy
contracts that will have not run off by June 2023. On March 23, 2021,
Treasury Secretary Janet Yellen agreed with Chairman Powell's assertion
and stated that the transition of certain legacy contracts would be
difficult without legislation, specifically noting, ``Congress does
need to provide legislation for the LIBOR transition.'' We understand
that these statements of support are the result of meaningful
examination of the issues and challenges involved.
State-by-State Patchwork Approach Is Not Viable
Recognizing the importance of legislative assistance to transition
away from LIBOR, on April 6, New York State passed AB164B \3\ into law.
The legislation provides businesses and consumers paying or receiving
LIBOR-based payments crucial clarity, minimizing adverse economic
impact and legal uncertainty in New York-based tough legacy contracts.
The bill passed by the New York State legislature was also consistent
with our five key principles.
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\3\ https://legislation.nysenate.gov/pdf/bills/2021/A164B
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This was a big, positive step forward in the orderly transition of
LIBOR as we estimate almost half of tough legacy contracts are governed
by the law of New York State. But a uniform Federal framework would
expand the protections to also include all other tough legacy contracts
remaining across the United States, allowing for all tough legacy LIBOR
contracts to transition on time and in an equitable and fair manner.
Timely and consistent treatment is crucial for the acceptance of the
replacement rate by the investing and borrowing public. The success of
the transition ultimately depends not only on the coordination across
easily amendable contracts, but also on the fair and timely resolution
of tough legacy contracts.
The most important reason for a Federal legislative approach is to
avoid the foreseeable downside risk to a State level approach. Simply
put, a State-by-State approach would provide fewer comprehensive
protections than what could be achievable at the Federal level given
the very limited time remaining until LIBOR's end in just over 2 years.
Additionally, we risk a patchwork of varying State laws, which would
compromise the very intent to provide a smooth transition.
State-by-State solutions cannot ensure all borrowers, lenders,
investors, and financial intermediaries of tough legacy contracts have
the same fair, equitable and consistent treatment across the country
which is paramount to ensuring the public and market confidence in the
fairness, viability and liquidity of the replacement rate they receive
for the remaining term of their contract. Ultimately, any States that
take no legislative actions will fail to articulate a path forward at
all, leaving Americans and their businesses with potentially negative
economic consequences and legal costs needed to protect their
interests. By providing the certainty of an equitable, liquid, and
transparent replacement rate and eliminating the potential for costly
litigation, the legislation recently passed in New York State will
serve to protect New York consumers, investors and other market
participants if their contracts are governed by New York law. Similar
legislation--adopted at the Federal level--would provide the same
protections to help ensure all consumers, investors, and borrowers
receive equitable and fair treatment regardless of where their contract
is governed.
Conclusion
In conclusion, let me thank you all again for your focus on helping
to transition our markets and economy away from LIBOR once and for all.
The work that some Members of this Committee are currently undertaking
is critical to ensuring that all investors, consumers, and business
borrowers and lenders are treated equally and fairly. It also will help
to prevent billions of dollars of potential litigation, where no one
wins but savers and retirees foot the bill.
Please know that the membership of the Structured Finance
Association has been committed to being part of the healthy evolution
and productive improvements in our markets as they continue their final
transition away from reliance on LIBOR, and we thank you for your work
in helping to facilitate this important market evolution.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM THOMAS WIPF
Q.1. In a recent speech, Federal Reserve Governor Randal
Quarles noted ``a handful of firms have said that they may want
more time to evaluate potential alternative rates'' to SOFR.
Please describe the consequences of these firms not following
the recommendations of the Alternative Reference Rates
Committee (ARRC) to transition to SOFR.
A.1. The ARRC believes that SOFR is the strongest alternative
to USD LIBOR. However, the ARRC's recommendations have always
been voluntary, and it recognizes that market participants may
choose other rates. With that in mind, it is important to note
that the ARRC has expressed its support for a vibrant and
innovative market with reference rates that are robust, IOSCO
compliant, and were available for use before the end of 2021 in
order to promote a timely transition. (Source: Freguently Asked
Questions Version: August 27, 2021)
Q.2. Please describe the consequences of some market
participants potentially continuing to use LIBOR after 2021,
including any potential risks to financial stability that could
arise.
A.2. The Financial Stability Oversight Council, the Financial
Stability Board and other domestic and global authorities have
emphasized the clear risk to financial stability posed by the
continued reliance on LIBOR. As such, the transition off of
LIBOR, and toward robust alternative rates that do not
reintroduce the vulnerabilities of LIBOR, is an important
foundation for financial stability going forward.
In the U.S., banking regulators have stated that they
believe there are safety and soundness concerns for supervised
entities that continue new use of U.S. dollar LIBOR this year.
The ARRC has supported this supervisory guidance and has
encouraged all market participants to end new use of U.S.
dollar LIBOR. Because LIBOR has been used in such a large
volume and broad range of financial products and contracts,
failing to take advantage of the next 15 months to wind down
legacy positions and instead continuing to create new LIBOR
contracts would pose a potential threat to individual financial
institutions and to financial stability.
It is estimated that current outstanding contracts
referencing USD LIBOR, including corporate loans, adjustable-
rate mortgages, floating rate notes (FRNs), securitized
products and a wide range of derivatives products, total more
than $200 trillion, roughly equivalent to 10 times U.S. Gross
Domestic Product. The ARRC has estimated that roughly \2/3\ of
these exposures will mature by June 2023; however, if new LIBOR
contracts continued to be written then there would be a much
larger set of contracts that would be forced to suddenly
transition when LIBOR ends. Without advanced preparation, a
sudden cessation of such a heavily used reference rate would
cause considerable disruptions to, and uncertainties around the
large gross flows of LIBOR related payments and receipts
between many firms. It would also impair the normal functioning
of a variety of markets, including markets for business and
consumer lending. Continuing to use LIBOR would seem to ignore
both its impending end and that its liquidity and usefulness
will likely continue to diminish; it will also impede the
ability of corporate borrowers and consumers to transition.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARREN
FROM ANDREW PIZOR
Q.1. Do existing student loan contracts that use LIBOR
generally specify the required replacement rate if LIBOR is
terminated?
A.1. No. Most existing LIBOR contracts grant note holders sole
discretion to choose a new rate to replace LIBOR without
specifying any particular replacement and also to make
adjustments at the note holder's sole discretion. For example,
a recent student loan contract from Discover states:
If the 3-month LIBOR Index is no longer available, we
will substitute an index that is comparable, in our
sole opinion, and we may adjust the Margin so that the
resulting variable interest rate is consistent with the
variable interest rate described in this paragraph. If
at any time the fixed or variable interest rate as
provided in this paragraph is not permitted by
applicable law, interest will accrue at the highest
rate allowed by applicable law.
It is also not clear that market participants have adjusted
their contracts to reflect the upcoming cessation of LIBOR.
Q.2. Please describe the implications of student loan servicers
having the discretion to choose an alternative rate to the
Secured Overnight Financing Rate (SOFR), including the impact
on student loan borrowers.
A.2. Allowing servicers the discretion to choose the
replacement rate creates significant risk for consumers. The
primary risk is that servicers will choose a rate that
generates more profit for them and the note holder by being
consistantly higher than LIBOR, such as the prime rate. Or they
may choose a rate that is unsuitable for other reasons, such as
a rate that is more volatile, one that is less representative
of market rates, one that is not based on actual transaction
data, or one that is easily manipulated--as the LIBOR was. For
example, as consumer advocates have noted, industry
representatives had advocated for the use of Ameribor and the
Constant Maturity Treasury (CMT) rate to replace LIBOR, even
though Ameribor is based on an extremely thin market relative
to the market SOFR references and CMT is based on
``indicative'' rate quotations instead of actual transaction
data.
Q.3. Are existing rules sufficient to protect against companies
putting any costs of the LIBOR transition onto consumers
through an increase in interest rates? If not, what new
protections are needed to mitigate any harms to student
borrowers?
A.3. No, they are not. Right now, companies can readily replace
LIBOR with rates that are more favorable to them at borrowers'
expense, and many contracts allow note holders to make
additional changes to the terms of consumer contracts (such as
adjusting the margin on the loan) in the context of the
adoption of a new reference rate that could put borrowers at
risk.
As we previously recommended to the Consumer Financial
Protection Bureau, several measures are necessary to protect
student borrowers:
The CFPB should signal its expectation that
industry participants will select SOFR as a replacement
index and that failure to do so will invite increased
scrutiny of compliance with Regulation Z.
Consumers should be informed at each critical stage
of the transition.
The CFPB should require that lenders and servicers
make information about the transition, including the
new replacement rate, readily available to existing and
prospective customers, even when their debts transition
to spread-adjusted SOFR.
It should be expected that institutions that
continue making loans that use the LIBOR as an index
ahead of the rate's cessation will add unambiguous
language to their loan contracts clearly articulating
the index that any LIBOR-based loan will fall back to
upon LIBOR's cessation and any associated changes that
will be made to the loan's margin at that time. Lenders
that do not adopt the ARRC's recommendations for
fallback language should be subjected to heightened
scrutiny from the Bureau.
The CFPB should use all available authorities to
ensure the timely transition away from LIBOR.
The Bureau's recently announced final rule is a strong step
in the right direction, but more is still necessary.
Additional Material Supplied for the Record
ICBA LETTER
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
LIBOR LETTER
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
CAMAC LETTER
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
NAFCU LETTER
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
BROOKLINE BANK LETTER
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
STATEMENT SUBMITTED BY SIFMA
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]