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LIBOR Update – IOSCO Voices Concern Over Widespread Use of Credit Sensitive Rates

September 13, 2021

On September 8, the board of the International Organisation of Securities Commissions (IOSCO) issued a statement  urging caution regarding the use of credit sensitive rates (CSRs) to replace LIBOR. To the good, IOSCO reiterated the importance of a “continued transition to robust alternative financial benchmarks, i.e., Risk-Free Rates, to mitigate potential risks arising from the cessation of LIBOR, including USD LIBOR.”

Over the past year, several CSRs have emerged to offer the market alternatives to the Secured Overnight Financing Rate (SOFR), the ARRC-recommended risk-free rate to replace USD LIBOR. (Additional detail on these CSRs can be found in the table below.)

In its statement, IOSCO expressed concern that widespread use of CSRs, instead of SOFR, may pose risks to financial stability. IOSCO highlighted SOFR’s robust underlying transaction volumes, observing they are “unmatched by other alternatives.”

IOSCO noted that CSRs will have to adhere to the IOSCO Principles on Financial Benchmarks  and that compliance with the IOSCO Principles is “not a one-time exercise and alternative benchmarks should be IOSCO compliant at all times.” In particular, IOSCO called on administrators to assess whether and to what extent the CSRs are “based on active markets with high volumes of transactions” and whether “such benchmarks are resilient during times of stress.”

Concern That CSRs Similar to LIBOR, Replicate LIBOR’s Shortcomings

Some of these rates are based on similar markets to LIBOR and may replicate many of LIBOR’s shortcomings, as highlighted by authorities in the US and UK. Users of benchmarks should also consider the robustness and reliability of the benchmarks they choose and ensure that they have reliable fallback mechanisms that can be used, should their chosen benchmarks cease or become unrepresentative.

– IOSCO Board

Global regulators responded to IOSCO’s statement voicing similar concerns:

Today’s statement by IOSCO further highlights the importance of using robust benchmarks when moving away from LIBOR. Markets should not risk the progress we've made by using supposedly credit sensitive rates that do not address LIBOR's fundamental weaknesses. These rates may well fail to comply with IOSCO Principles if their use became widespread. We need to learn the lessons of LIBOR, and ensure we transition to lasting solutions. I welcome IOSCO’s commitment to monitor the ongoing compliance of financial benchmarks, including credit sensitive rates, with its Principles.

– Andrew Bailey, Governor of the Bank of England

Compliance with all of the IOSCO Principles—consistently over time—is essential to a successful and lasting transition from LIBOR. With this in mind, market participants should now be moving to robust reference rates like SOFR to avoid jeopardizing financial stability.

– John C. Williams, President of the Federal Reserve Bank of New York

A Comparison Across LIBOR Alternatives

An overview of the leading CSRs is provided in the table below. Like SOFR, the CSRs incorporate a bank credit risk component, which some view as more robust that the credit spread adjustment embedded in LIBOR. However, as noted above, the underlying transaction volume of the CSRs is a fraction of SOFR’s underlying volume.

IOSCO expressed concern that widespread use of CSRs, instead of SOFR, may pose risks to financial stability.