Remarks of Commissioner Rostin Behnam at the ISDA/SIFMA AMG Benchmark Strategies Forum 2020, New York, New York
February 12, 2020
Good morning. I want to thank Scott O’Malia and his staff at the International Swaps and Derivatives Association (ISDA) and SIFMA AMG for holding this important event and giving me an opportunity to participate. Before I begin, please allow me to remind you that the views I express today are my own and do not represent the views of the Commodity Futures Trading Commission (“CFTC” or “the Commission”) or my fellow Commissioners.
While I would like to believe that my sharp delivery and silver tongue are the reasons why Scott and ISDA keep bringing me back for events like this, I know the truth is that I have more than likely simply earned the spot for being persistently engaged and dogged in my message. I arrived at the Commission just a few months after Andrew Bailey, Chief Executive of the UK Financial Conduct Authority (FCA) and soon-to-be Governor of the Bank of England, acknowledged that despite significant improvements to LIBOR in the wake of scandal, the goal of anchoring LIBOR (the London Inter-Bank Offered Rate) submissions and rates to the greatest extent possible to actual transactions could not be achieved. The systemically important benchmark was in a critical, terminal condition, and through negotiation, will remain live until the end of 2021. Even then it was clear we were potentially facing a future of a non-representative LIBOR when the panel banks’ palliative submissions would no longer support LIBOR’s function as a representative benchmark. A global cooperative effort led by regulatory authorities working closely with the public and private sectors was the only path to make it to the LIBOR “end game” as Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, has dubbed it. As a newly sworn-in market regulator, I knew I had to take action immediately and commit myself and my resources to ensuring that LIBOR would pass smoothly to a new alternative set of risk-free reference rates (“RFRs”).
My first commitment was to take over sponsorship of the CFTC’s Market Risk Advisory Committee (MRAC). The MRAC advises the Commission on matters relating to evolving market structures and the movement of risk across clearinghouses, exchanges, intermediaries, market makers and end users. It examines systemic issues that threaten the stability of derivatives and other financial markets, and makes recommendations on how to improve market structure and mitigate risk. MRAC members include representatives from clearinghouses, exchanges, intermediaries, academia, and market participants. In July of 2018, I convened MRAC to focus on benchmark reform in an effort to unpack the myriad impending issues specifically related to the derivatives market.
Soon thereafter, the Commission voted to establish the Interest Rate Benchmark Reform Subcommittee (“Subcommittee”) to provide reports and recommendations to the MRAC regarding efforts to transition U.S. dollar derivatives and related contracts to SOFR (the Secured Overnight Financing Rate), the RFR for the US dollar, selected through a public-private committee convened and sponsored by the Federal Reserve to facilitate the transition in the U.S. known as the Alternative Reference Rates Committee or ARRC, and the impact of such transition on the derivatives markets. Tom Wipf chairs the Subcommittee. Tom also serves as the chair of the ARRC and is on ISDA’s Board, so I am pretty confident we found the right person for the job.
My goal at the time was to use the subcommittee to complement the work of the ARRC by raising awareness and shedding light on the potential challenges as we head towards 2021, identifying the risks for financial markets and individual consumers, and, above all else providing solutions within the derivatives space.
Today, I would like to provide you an overview of our current efforts here in the U.S., with a focus on recent progress of the ARRC and the Subcommittee, and some initiatives that are kicking off shortly. I’m cognizant that you have a full day ahead of you, and will hear from many distinguished guests. Therefore, I will keep these remarks brief so that we have some time for questions at the end.
The Word of the Day is “Progress”
American architect, inventor, systems theorist, author, designer, futurist and environmental activist Richard Buckminster Fuller is quoted as saying, “You never change things by fighting existing reality. To change something, build a new model that makes the existing model obsolete.” Bucky, and, yes, he did go by that, passed away in 1983, but being a futurist, his words on progress are apt for today.
We have all agreed that to avoid LIBOR risks, we must move away from it altogether; we must find a new model that makes LIBOR obsolete. Across the globe, our various jurisdictions have chosen new RFRs, and liquid markets for swaps and futures are building around them. ISDA has led the charge on an initiative—at the request of the Financial Stability Board’s Official Sector Steering Group (FSB OSSG)—to identify fallbacks for derivatives contracts referencing certain key IBORs(Inter-Bank Offered Rates). These contractual fallback provisions will provide for adjusted versions of RFRs as replacement rates upon the discontinuation of the relevant IBOR and will be incorporated into ISDA’s Definitions via a protocol for derivative contracts as amendments.
In the U.S., to support the transition to SOFR, the ARRC developed the Paced Transition Plan, which specifies steps and provides timelines designed to support and encourage SOFR adoption. A 2019 set of Incremental Objectives complements the Transition Plan by outlining key priorities and milestones to support and prepare market participants for the transition. To build liquidity, the ARRC has focused on supporting the launch and usage of SOFR-based financial products in the market. As of the end of January, notional amount outstanding in SOFR swaps was $2.1 trillion (USD), and in SOFR futures, $1.6 trillion (USD). We are seeing a regular increase in traded volumes and notional outstanding for both futures and swaps.
As a complement to ISDA’s work on benchmark fallbacks in the derivatives space, the ARRC has released final recommended language on USD LIBOR fallback contract language for syndicated loans, bilateral loans, floating rate notes and securitizations. These provisions may be used by market participants in both legacy and new contracts that reference LIBOR and are intended to reduce the risk of serious market disruption upon a determination that LIBOR is no longer viable. I just want to take a moment to acknowledge the great care that has been taken by the different ARRC working groups to achieve consistent outcomes across the various cash and loan markets, in addition to ISDA’s work on derivatives.
In response to ARRC requests, last December the, three divisions of the CFTC issued staff no-action letters providing relief to market participants relating to the transition of swaps referencing IBORs. More specifically, the Division of Swap Dealer and Intermediary Oversight issued CFTC Letter 19-26 providing relief to swap dealers from registration de minimis requirements, uncleared swap margin rules, business conduct requirements confirmation, documentation, and reconciliation requirements, and certain other eligibility requirements. The Division of Market Oversight issued CFTC Letter 19-27 providing time-limited no-action relief from the trade execution requirement, while the Division of Clearing and Risk issued CFTC Letter 19-28 providing time limited relief from the swap clearing requirement and related exceptions and exemptions.
Also in December, the five agencies generally referred to as the U.S. prudential regulators reopened the comment period on a proposed rule to change swap margin rules to facilitate the implementation of prudent risk management strategies at certain banks and swap entities to allow commenters additional time to analyze the proposed rulemaking. In part, to aid in the transition away from LIBOR the proposed rulemaking would allow certain technical amendments to legacy swaps without altering their status under the swap margin rules.
Last week, the Federal Housing Finance Agency (FHFA) announced that the government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac will stop accepting adjustable-rate mortgages (ARMs) based on LIBOR by the end of 2020. The GSE’s announced that they plan to begin accepting ARMs based on SOFR later in 2020. FHFA has worked with Fannie Mae and Freddie Mac to develop a model for a SOFR-based ARM. Both Fannie Mae and Freddie Mac also announced they would adopt the fallback language the ARRC recommended to ensure contracts would continue to be effective in the event that LIBOR is no longer usable. FHFA’s regulated entities are now regular issuers of SOFR-indexed debt. FHFA has instructed the Federal Home Loan Banks (FHLBs) to stop purchasing LIBOR-based investments with maturities that extend past December 31, 2021. It has also instructed the FHLBs to no longer enter into other LIBOR-based transactions involving advances, debt, derivatives, or other products with maturities beyond December 31, 2021 as of March 31, 2020, with only limited exceptions granted by FHFA.
While I could keep going, I will pause here to simply state that while we have made tremendous progress to date from a regulatory and market perspective, time is running short to make our transition complete. There are still too many firms fighting the existing reality by failing to ensure that contracts that do rely on LIBOR have clear, effective fallbacks to address the prospective end of LIBOR. While some participants might prefer that regulators force the change through rule making, this is not the approach global authorities have taken. Authorities have stood ready to facilitate, but our policies, mandates, and missions do not always support requiring compulsory industry standard setting or change through regulation. Nevertheless, as we move further into 2020, and the FCA has made it even more clear that to the extent a non-representative LIBOR could exist, its lifetime would amount to a relatively brief period of unpredictability and likely, volatility. It remains critically important that we have broad participation in the consultative efforts led by the ARRC and ISDA, as well as those raised in the MRAC.
Getting back to MRAC, I am proud of the accomplishments and progress made by the MRAC and the Subcommittee’s work and contributions to the larger efforts by our domestic and international counterparts. As an important first deliverable in September, the MRAC approved plain English disclosures for new derivatives referencing LIBOR and other IBORS.
This standard set of disclosures, prepared by the Interest Rate Benchmark Reform Subcommittee, is intended as a helpful example of “plain English” disclosures that market participants could use, as they deem appropriate, with all clients and counterparties with whom they continue to transact derivatives referencing LIBOR and other IBORs. The disclosures inform clients and counterparties about the implications of using such products and provide additional transparency to the market. That said, the “plain English” disclosures are not meant and should not undermine efforts to complete the transition in an orderly and timely manner. More generally, the disclosures provide a tool as we collectively work towards completing the transition away from LIBOR.
During our last meeting on December 11, 2019, the Interest Rate Benchmark Reform Subcommittee provided a status report covering its three work streams: (1) the Initial Margin Working Group (2) the Clearing Working Group; and (3) the Disclosure Working Group. We also heard from the CFTC’s Office of the Chief Economist (OCE) and the Initial Margin Working Group on the impact of transitioning certain legacy IBOR-linked derivatives to risk free rates. Specifically, Richard Haynes, a CFTC Supervisory Research Analyst, discussed an OCE-published CFTC research paper, “Legacy Swaps under the CFTC’s Uncleared Margin and Clearing Rules.” The paper provides important data about the landscape for legacy swaps, which are swaps executed prior to the implementation of the CFTC’s Title VII margin and clearing mandate. I believe the paper’s conclusions cement the important role the CFTC and other regulators should play in providing critical market data and regulatory relief for market participants, where needed and when appropriate, as we collectively stride towards benchmark transition.
The penultimate discussion centered on ISDA’s fallback consultations, including pre-cessation triggers and the parameters for benchmark fallback adjustments. These are critically important issues, and as I will discuss shortly, are going to take center stage in the next months. Among many other efforts since 2016, ISDA has spearheaded this critical work as part of the larger global benchmark transition effort, and the entire organization deserves recognition for excellent and timely work.
The final discussion featured proposals from the CME and LCH for transitioning price alignment interest (PAI) and discounting for U.S. dollar over-the-counter cleared swaps to SOFR. This discussion was a continuation from the September 2019 meeting. Differences between the respective proposals were recognized as potentially economically and operationally challenging, but the message from the Subcommittee was clear: consistency across clearinghouses is key. CME and LCH have coalesced around a single transition date in mid-October 2020, “the Single Step” event. Given the operational challenges and hugely critical importance of this event, and to improve market transparency into the economic and operational dynamics of a single-step transition, the Subcommittee recommended that the MRAC sponsor a “table-top” exercise involving both clearinghouses, clearing members, dealers, clients and end-users, well in advance of the October 2020 switch date. The Subcommittee is currently considering the parameters and timing of a table-top exercise and I hope to announce the specifics in the near future.
Addressing the Challenges Ahead Head-On
Many challenges remain that demand thoughtful consideration and eventual execution in order to globally harmonize transition away from LIBOR. Most recently, the focus has been on consideration of a pre-cessation trigger as a step towards greater market certainty. Another concern involves how non-EU jurisdictions, including the U.S., should respond if there is a determination under the European Benchmark Regulation that LIBOR, although still published, is non-representative of the underlying market.
We can all rest assured that ISDA has taken the reins again and last week announced that it will re-consult on how to implement pre-cessation fallbacks. The decision followed the release of new information by the FCA and ICE Benchmark Administration on the limited lifespan of non-representative LIBOR and the issuance of a consultation by LCH to proposals by LCH to build pre-cessation triggers into its rulebook. The new consultation is anticipated to be issued later this month and will ask whether the 2006 ISDA definitions should be amended to include fallbacks that would apply to all covered derivatives following the permanent cessation of an IBOR or a “non-representative” pre-cessation event—whichever were to come first. A single protocol would be launched to allow participants to include both pre- and permanent cessation fallbacks within their legacy derivatives.
I am very pleased that ISDA is re-consulting on pre-cessation fallbacks. Given the risks associated with a non-representative or Zombie LIBOR, it is not only critical to provide for a pre-cessation trigger, but it is important to have a single protocol in place well in advance of 2021. I encourage market participants to focus on the benefits of pre-cessation triggers in terms of clarity, certainty, and avoidance of risk. As my colleagues at the FCA have pointed out, including an additional pre-cessation trigger into standard swaps fallback language will ensure a level playing field and avoid the pricing mismatches between triggered and non-triggered contracts—which is what could occur were pre-cessation triggers be offered as an option. ISDA is providing this second opportunity to build consensus. While we regulators are here to assist, an industry-led solution remains the preference.
As we continue full force in 2020, much work remains to be done in less than two short years. The ARRC’s paced transition plan assumes significant transition to SOFR in 2020. Operational readiness becomes crucial to ensure organizations have set a solid foundation internally to begin transition in earnest. I remain committed to supporting this entire effort, working with market participants and my official sector colleagues to ensure the MRAC continues to play an additive role in addressing challenges in a thoughtful, measured way to ensure market continuity and stability.
I began these remarks with some thoughts on progress from the ultimate Renaissance man, Bucky Fuller. Bucky was a huge proponent of the world view known as Spaceship Earth which encourages everyone on earth to act harmoniously—like the crew of a ship—toward the greater good. It is a bit of a heavy concept for this hour of the morning, but it is the right idea as we think about how our collaboration, coordination, and communication have already brought us this far in the last few years in terms of progress. To make that final pass, we just need to continue our efforts and make some hard decisions for the greater good of our markets.
 Andrew Bailey, Chief Executive, Financial Conduct Authority, Speech at Bloomberg London: The Future of LIBOR (July 27, 2017), https://www.fca.org.uk/news/speeches/the-future-of-libor.
 Edwin Schooling Latter, Director of Markets and Wholesale Policy, Financial Conduct Authority, Speech at the Risk.net LIBOR Summit, 2019 (Nov. 21, 2019), https://www.fca.org.uk/news/speeches/next-steps-transition-lib.
 Press Release Number 7752-18, CFTC, CFTC’s Market Risk Advisory Committee Announces Agenda for July 12 Public Meeting (July 10, 2018), https://www.cftc.gov/PressRoom/PressReleases/7752-18.
 Press Release Number 7819-18, CFTC, CFTC Commissioner Behnam Announces the Establishment of New Subcommittee of the Market Risk Advisory Committee and Seeks Nominations for Membership (Oct. 3, 2018), https://www.cftc.gov/PressRoom/PressReleases/7819-18.
 Press Release Number 8096-19, CFTC, CFTC Provides Relief to Market Participants Transitioning Away from LIBOR (Dec 18, 2019), https://www.cftc.gov/PressRoom/PressReleases/8096-19.
 News Release Number 2019-152, Office of the Comptroller of the Currency, Agencies Extend Comment Period for Proposed Rule to Amend Swap Margin Rules (Dec. 20, 2019), https://occ.gov/news-issuances/news-releases/2019/nr-ia-2019-152.html.
 See FHFA, Libor Transition, https://www.fhfa.gov/SupervisionRegulation/LIBORTransition.
 See Letter from Richard Fox, Head of Markets Policy, The Financial Conduct Authority to Scott O’Malia and Katherine Darras, ISDA (Jan. 20, 2020), https://www.isda.org/a/E1LTE/FCA-letter-to-ISDA-on-Non-representative-LIBOR-January-2020.pdf.
Press Release Number 8011-19, CFTC, Market Risk Advisory Committee Approves Plain English Disclosures at Public Meeting (Sep. 13, 2019), https://www.cftc.gov/PressRoom/PressReleases/8011-19.
 Information on all of the MRAC meetings, including press releases, archived webcasts, and presentation materials are available at https://www.cftc.gov/About/CFTCCommittees/MarketRiskAdvisoryCommittee/mrac_meetings.html.
 John Coughlan, Richard Haynes, Madison Lau, and Bruce Tuckman, Office of Chief Economist, CFTC, Legacy Swaps Under the CFTC’s Uncleared Margin and Clearing Rules (November 2019), https://www.cftc.gov/sites/default/files/2019-11/CFTC%20Legacy%20Swaps%20Analysis%202019.11.19.pdf.
 Letter from Co-Chairs of the Financial Stability Board’s Official Sector Steering Group to ISDA (Mar. 12, 2019), https://www.fsb.org/wp-content/uploads/P150319.pdf.
Edwin Schooling Latter, Director of Markets and Wholesale Policy, Financial Conduct Authority, Next Steps in Transition from LIBOR, (Nov.11, 2019), https://www.fca.org.uk/news/speeches/next-steps-transition-libor.
 Press Release, ISDA, ISDA to Re-consult on Pre-cessation Fallbacks (Feb. 5, 2020), https://www.isda.org/2020/02/05/isda-to-re-consult-on-pre-cessation-fallbacks/.
 See Edwin Schooling Latter, supra note 2.