Libor alternative isn't a one-size-fits-all benchmark
While most of the nation is on lockdown during the coronavirus pandemic, megabank lobbyists are plotting to sneak a provision into New York law that would benefit them and yet, affect nearly every bank and business in the country.
The proposed legislation is part of a massive transition in which banks are shifting from using the London interbank offered rate as an index benchmark for many loan contracts, to another alternative. The Bank of England plans to sunset the Libor index at the end of 2021 (which may be extended, somewhat due to COVID-19) because some megabanks there fraudulently manipulated the rate to their profit.
Oddly, a committee dominated by a different set of large financial firms is pushing for New York lawmakers to mandate the Secured Overnight Financing Rate as the fallback replacement for Libor-based contracts. For years, this group called the Alternative Rate Reference Committee (ARRC) has been acting as the private-sector working group with federal regulators to come up the SOFR alternative, an index rate which the New York Fed now publishes.
However, it’s important to know that the SOFR index is largely predicated on a dozen big banks and a handful of the largest financial firms that make up the ARRC. With New York as the nation’s major financial hub, many financial contracts originate there and have to comply with New York law while potentially impacting the country’s financial system.
Meaning, if the megabanks are successful in getting their provision tucked into New York law, they will have a good shot at imposing SOFR everywhere in the U.S.
If the rates committee succeeds in influencing New York lawmakers to command that SOFR be the fallback index for trillions of dollars of loans, it would be enormously beneficial to these banks for a variety of reasons.
First, since the SOFR index is largely controlled by megabanks and firms, it will reflect only their economics, which are tied deeply into the securities trading markets and does not reflect the realities of real commercial businesses.
As a result, if the megabanks make it that all financial institutions must default to SOFR, the costs of lending to commercial firms will be determined not by their local banks but by opaque trading in a market only transparent to these dozen or so big bank ARRC participants.
This is not a theoretical problem. In September 2019, the SOFR market went haywire and rates skyrocketed 10%, forcing the Federal Reserve to stabilize it. Were SOFR to become the rate affecting every U.S. business, either costs to the business would go crazy due to some trader at a big bank, or the Fed would be forced to constantly intervene every time a megabank’s trading sandbox went slightly off-kilter.
Secondly, the proposed legislation by the ARRC calls for only the SOFR to get a safe harbor from litigation. Other alternative bank indexes that might work better for the majority of banks in the U.S. that often serve Main Street businesses would not have that benefit.
For example, Signature Bank of New York (my bank) prefers an index called Ameribor, which is transparent and reflects the lending costs of myriad Main Street banks beyond the megabanks. Ameribor is transparent and conforms to all 19 IOSCO principles for an index. However, in this litigious world, every bank would naturally be forced to adopt the SOFR index if that’s the only one with a safe harbor bestowed by law.
Why else would the megabanks be so determined to take away choice from the rest of the industry, especially when there are at least two other good alternatives that reflect the overwhelming majority of banks?
Megabank lobbyists are misleading New York lawmakers by claiming there is no controversy. Many midsize banks and regional banks have written to the Fed stating that there are major problems with using SOFR, and it has been a topic of discussion before Congress. Even Fed Chairman Jerome Powell has been questioned about this before both the House and Senate.
Instead, lawmakers should pass a bill that gives the overwhelming majority of banks and businesses choice. Pass a law that gives any transparent, transaction-based and audited benchmark a safe harbor.
Bottom-line message to New York lawmakers: Yes, the end of Libor is a problem that needs alternatives, but don’t let that be an opportunity for the megabanks to impose their will and gain with another oligopoly on the rest of the nation’s banks and businesses. Let lenders adopt any fair and transparent index that works well for them and their clients.