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From Securities Regulation Daily, January 25, 2019

ICE Benchmark Administration floats alternative to LIBOR

By Lene Powell, J.D.

Anticipating a market movement away from the LIBOR benchmark interest rate, the current LIBOR administrator is seeking comment on a new proposed benchmark that would be based on observable transactions and better reflect current bank funding models.

In a new paper, ICE Benchmark Administration (IBA) has proposed a new short-term benchmark interest rate to meet the needs of lenders, borrowers, and other users of cash products. Designed as an alternative to LIBOR, which IBA also oversees, the U.S. Dollar ICE Bank Yield Index would be fully transaction-based, reducing the potential for manipulation. If the market responds positively and testing is successful, IBA anticipates launching the benchmark during the first quarter of 2020.

Need for LIBOR alternative. Historically, LIBOR is the most widely used interest rate benchmark, but many have called for replacement reference rates. LIBOR manipulation has been the subject of many major enforcement actions by the CFTC and other regulators, as well as private actions by market participants. According to the IBA paper, LIBOR faces an "uncertain future" due to a decline in transactions that underpin it, due to a change in bank funding models.

Among those recommending replacement of LIBOR is the Alternative Reference Rates Committee (ARRC), a group of private market participants convened by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York, in cooperation with banking regulators and the CFTC and SEC. In an FAQ, the committee says that financial markets need to plan for a transition away from LIBOR to a more durable and robust alternative, including potentially its own proposed benchmark, the Secured Overnight Financing Rate (SOFR).

New proposed benchmark. The proposed U.S. Dollar ICE Bank Yield Index would be based entirely on two types of U.S. dollar-denominated transactional input data: primary market wholesale, unsecured funding transactions for large, internationally active banks; and secondary market transactions in wholesale, unsecured bonds issued by large, internationally active banks. IBA would refine and process this data to construct a yield curve to obtain one-month, three-month and six-month term settings, providing an indication of average investment yields for short-term, unsecured bank debt obligations.

According to IBA, while derivatives market participants should be able to transition to LIBOR alternatives without too much difficulty, participants in lending and other cash markets may face greater challenges. The proposed index satisfies the key elements of interest rate benchmarks that users in the cash markets have historically sought, in that it seeks to measure the average yields at which investors are willing to invest in the unsecured debt obligations of a broad set of large, internationally active banks for specified forward-looking tenors. Two factors contribute to robustness: it is underpinned entirely by transaction data, and it uses data from both primary funding markets and the secondary bond market, reflecting the increased use of the bond market for bank funding since the financial crisis.

Feedback sought. The paper describes methodology and testing results for the new proposed index and asks 16 questions for feedback. Comment will be accepted until March 31, 2019.

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