What has happened?
In 2014, the Fed set up an Alternative Reference RatesCommittee. Last week the Committee proposed two possible replacements for LIBOR.
Why did the Fed instigate the Alternative Reference Rates Committee?
US regulators and US banks never liked USD LIBOR, which is a rate that is set (by definition) in London. In their view it is an eyesore that the whole market uses a rate for USD money market instruments that is not set in New York. Over the years we have seen many initiatives in this field, but so far none has been able to replace USD LIBOR. The official line is that US regulators and bankers want real-life transactions to replace the indicative quotes of LIBOR. They argue that by anchoring the rate into transactions, it is less prone to manipulation.
What are these new LIBOR replacing benchmarks?
The Committee identified the Fed’s Overnight Bank Funding Rate (OBFR) and the Overnight Rate on US Treasury securities as possible alternatives. With USD300bn worth of daily trades, the Committee feels the two rates are “robust” and fit for purpose.
Fed Governor Jerome Powell said: “The case for moving ahead to a new benchmark is very strong. The new benchmark is going be robust with a lot of transactions and will be resistant to manipulation,”
Why are they not proposing to use Fed Funds?
There was some discussion of using the Fed funds. But Fed funds were rejected. We think because it has been around for long and the market did not warm to it. Others have said it was rejected because it harboured limitations to change monetary policy framework later on. How that works exactly, is however beyond us.
What are the next Steps?
The next step is for the public to comment on the proposal until the 15th of July. There will be a roundtable discussion at the NY Fed on June 21 to facilitate discussion.