Why the Global Libor Transition Depends on U.S. CFTC Action

U.S. Treasury Secretary Janet Yellen observed recently that reference rate reform is at “a critical juncture, and more must be done to facilitate an orderly transition.” In order to facilitate an orderly transition away from Libor, the U.S. Commodity Futures Trading Commission must take immediate action to support the move from Libor-based derivatives to alternative reference rates this summer.

Certain Libor rates will cease publication at the end of this year. “Libor is over,” said Federal Reserve Vice Chairman Randal Quarles. Time is of the essence. The CFTC should move swiftly to require that U.S. interest rate swaps based on non-Libor reference rates be cleared by a regulated derivatives clearing organization. Currently, the CFTC only requires the clearing of Libor-based U.S. dollar interest rate swaps but not U.S. dollar interest rate swaps tied to other reference rates.

This mandate requires CFTC action, and only the CFTC can initiate this process. As then-CFTC Chairman Gary Gensler, now chair of the Securities and Exchange Commission, noted in 2012, “central clearing is one of the three major building blocks of Dodd-Frank swaps market reform.” In order to bring Dodd-Frank’s mandate to reduce systemic risk and promote consumers into the next decade, the CFTC should expand the clearing mandate beyond Libor-based interest rate swaps.

Rapid action by the CFTC to impose a clearing mandate for non-Libor based interest rate swaps will lead to increased swaps trading activity, which will provide the liquidity and price discovery necessary to promote a robust derivatives market. A highly liquid, competitive derivatives market is necessary to facilitate the very important underlying cash market activity.

Recently, a CFTC advisory subcommittee, composed of market experts, recommended certain market best practices for switching interdealer trading conventions from Libor to SOFR for interest rate swaps. This initiative, and other work being undertaken by the Alternative Reference Rates Committee and others, should be encouraged and supported. But it is not the same as affirmative agency action.

A clearing mandate will push trading into cleared interest rate swaps with new reference rates. It will signal to market participants that the necessary economic conditions exist to trade in these interest rate swaps markets. While trading has increased in certain non-Libor swaps, futures, and options, markets haven’t yet reached the “tipping point.”

In addition, a CFTC clearing mandate is a prerequisite for registered swaps trading venues to petition to make these instruments traded on regulated exchanges. Dodd-Frank encouraged the trading of swaps on these facilities, which promote pre-trade price transparency and protect the integrity of derivatives markets.

The Libor transition has been years in the making. Today, the question is not whether there will be a transition. The question is how disruptive the transition might be. And whether policymakers used all of the tools at their disposal.

If the CFTC requires clearing of these new interest rate swaps linked to non-Libor benchmarks, the transition may be relatively smooth.


Matthew Kulkin is the former director of the Division of Swap Dealer & Intermediary Oversight at the Commodity Futures Trading Commission and currently a partner and co-chair of the Financial Services Practice Group at Steptoe & Johnson LLP in Washington, D.C.

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