As the global financial industry prepares to embrace new financial benchmarks, global securities regulators are warning that the shortcomings of LIBOR — the long-standing benchmark they’re replacing — could be repeated.
In a statement, the International Organization of Securities Commissions (IOSCO) called on the financial industry to ensure that the alternative rates that are used in place of LIBOR are robust and not susceptible to the same weaknesses that undermined the integrity of LIBOR.
“Regulators are concerned that some of LIBOR’s shortcomings may be replicated through the use of credit sensitive rates that lack sufficient underlying transaction volumes,” they said.
The statement indicated that “credit sensitive rates,” which are benchmarks built to measure the credit risk of unsecured borrowing in certain markets, are being touted as possible replacements for U.S. LIBOR.
“Some of these rates are based on similar markets to LIBOR and may replicate many of LIBOR’s shortcomings,” IOSCO said.
In particular, it warned, “The disproportionality between the low/modest volume of transactions underlying credit sensitive rates and the increasingly higher volumes of activity in markets referencing them — the so-called inverted pyramid problem — raises concerns about market integrity, conduct risks and financial stability risks.”
Additionally, the regulators noted they’re concerned that transaction volume in credit sensitive rates tends to decline during periods of market stress, as it did during the onset of the Covid-19 pandemic — heightening regulators’ fears about their suitability.
“The sound functioning of systemically important benchmarks is vital to the global economy and financial markets,” said Ashley Alder, chair of IOSCO and CEO of the Securities and Futures Commission of Hong Kong. “Therefore, it is crucial that potential alternative rates to LIBOR are especially robust and reflect credible underlying markets underpinned by a sufficient volume of transactions to avoid the problems we have experienced with LIBOR.”
IOSCO stressed that industry firms should consider the reliability and robustness of the benchmarks they chose to use, adding that the regulators will closely monitor whether rates are compliant with the principles developed by regulators to ensure that benchmarks are reliable and robust.
“In light of the recent regulatory concerns about the insufficient activity in markets underlying certain credit sensitive rates, compliance with the IOSCO benchmark principles at all times is fundamentally important. IOSCO will closely watch market developments in this respect,” Alder said.
Commenting on IOSCO’s warning, Andrew Bailey, governor of the Bank of England, said, “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,” Bailey added.