Remarks by William Dudley, former President and CEO of the Federal Reserve Bank of New York, at the Bank of England’s Markets Forum 2018, London, 24 May 2018.
LIBOR continues to have significant shortcomings despite strengthened governance in recent years, and uncertainty about its future will only grow over time. This uncertainty reflects the limited liquidity underlying LIBOR and corresponding legal risks. But, I am also skeptical about whether LIBOR can ever be adequately transaction-based. There is no guarantee that LIBOR will continue to exist beyond December 2021. In my view, LIBOR is likely to go away, and it should, because it is not supported by a sufficiently robust regime. The LIBOR countdown clock should provide an impetus for action, but it should also make market participants and regulators increasingly nervous as we approach the deadline-especially if longer-term solutions are not in train or in place. Time is of the essence, and we must manage it well. The ARRC (Alternative Reference Rates Committee) and others have laid out valuable transition plans, and we need to ensure that they are executed expeditiously and well.
This is a monumental and complicated effort-one that the industry has never undertaken, and it will entail overcoming many obstacles. It requires collective action by a wide variety of market participants, some of whom may not be fully convinced of the need for change. And, there may be others with a direct interest in the preservation of LIBOR-such as its administrator-who may not support moving away from the status quo. There also undoubtedly will be those who seek a free ride on the efforts of others. And, of course, the effort will encounter inertia and wishful thinking. All of this is to be expected in such a large undertaking with significant upfront costs. Nevertheless, delay is not a viable option.
This task is borne out of necessity. Financial crises typically result when we fail to identify vulnerabilities, and then unexpected triggers turn those vulnerabilities into points of weakness that can lead to catastrophic failure. The discontinuation of LIBOR, however, is different. We can see it coming, and we know the impact of a disorderly transition would be huge. Therefore, a half-hearted effort or a failure to act would be inexcusable, especially after all we have learned from the experience of the financial crisis. Moving this core piece of the global financial system to a firm and durable foundation is essential and worth the cost.
This task is admittedly hard, but I am optimistic given our past successes. We have demonstrated that effective collective action can provide solutions to longstanding structural vulnerabilities in the financial system. A key lesson from the crisis is that structural vulnerabilities must be addressed continually. If they are ignored, larger problems eventually will result. For example, through collective action over the past decade, we have successfully addressed structural weaknesses in the tri-party repo market, the over-the-counter derivatives market, and money market mutual funds.
Each of these challenges required a tailored solution that relied on different tools-including a diverse mix of market, regulatory and supervisory measures-to get the job done. Everything isn’t a nail, and the best tool is not always a hammer. You have to identify the problem that needs fixing and select the right tool for the job. This is likely to require both official sector engagement and private sector initiative.
The transition away from LIBOR represents a significant risk event for firms of all sizes, and they should actively manage this transition through their existing frameworks for identification, management, and mitigation of risk. Supervisors should continue to support this objective by ensuring that all firms are aware of the transition and that LIBOR-related issues are being addressed in a way that is commensurate with a firm’s exposures and risks. More broadly, the official sector will continue to push market participants to take all necessary steps to mitigate the risks to financial stability from a disorderly transition.
In closing, the LIBOR scandal certainly was one low point among many during the financial crisis and its aftermath. It highlighted the need for reform of a critical area of the global financial system. We have made considerable progress since then, but reform still has a long way to go. The remaining work, by necessity, will involve purposeful collective action and engagement across the financial industry to address market-wide issues. It also will require firm-specific action to manage individual risks. The challenge is that the window for action is narrowing. Therefore, we must redouble our efforts to ensure a successful transition from LIBOR to a more sound and durable regime.