Senate Committee on Banking, Housing, and Urban Affairs

The Libor Transition: Protecting Consumers and Investors

Tuesday, November 2, 2021


Opening Statements
Chairman Sherrod Brown (D-Ohio)
In his opening statement, Brown recounted the consequences of the financial crisis and explained the London Interbank Offered Rate (LIBOR) scandal and legacy contract issue. He discussed the LIBOR transition and Secured Overnight Financing Rate (SOFR) rate and expressed appreciation for Sens. Jon Tester (D-Mont.) and Tom Tillis’ (R-N.C.) work on the legacy contract issue. He also explained progress made in the House Financial Services Committee to address legacy contracts and the Adjustable Interest Rate Act. Brown described the LIBOR issue as cleaning up after the biggest banks.

Ranking Member Pat Toomey (R-Penn.)
In his opening statement, Toomey summarized the LIBOR transition and stated the need for federal legislation to address tough legacy contracts, which should be narrowly tailored and not affect any new contracts. He said there should be amendments to the Adjustable Interest Rate Act to clarify that non-SOFR benchmark rates are not disfavored in future contracts and that for new contracts, banks should be able to choose non-benchmark rates. He expressed concern that the Office of the Comptroller of the Currency would scrutinize non-SOFR rates disproportionately to SOFR and that regulators are pressing all banks to use SOFR without any transparency or public input.

Mr. Thomas Wipf, Chair and Managing Director, Alternative Reference Rate Committee (ARRC) and Morgan Stanley
In his testimony, Wipf said the ARRC believes that SOFR is an appropriate rate for new use in products that have historically referenced LIBOR and that it is robust enough to ensure that we do not recreate the problems that we have had to deal with in LIBOR. He said they also support choice and have been clear that their recommendations are voluntary. He mentioned New York and Alabama passing legislation to address the risks of LIBOR transition and acknowledged that they cannot reasonably hope for comparable legislative solutions in all 50 states and the District of Columbia. Wipf said federal legislation is necessary because it can help ensure an equal outcome for all Americans.

Mr. Andrew Pizor, Staff Attorney, National Consumer Law Center
In his testimony, Pizor said the credit industry should adopt the ARRC’s recommended replacement, SOFR, and that Congress should mandate use of the SOFR or offer a safe harbor for voluntary use. Pizor said the National Consumer Law Center (NCLC) supports the concept of a safe harbor but believes the language is too broad and could allow bad actors to escape responsibility. His main recommendation was that the Senate should pass a bill modeled on H.R. 4616 but with a more limited safe harbor connected to a narrow definition of “conforming changes” to be provided by the Federal Reserve Board.

The Honorable J. Christopher Giancarlo, Former Chairman, U.S. Commodity Futures Trading Commission
In his testimony, Giancarlo said there is a clear consensus that federal legislation is necessary to ensure smooth and efficient transition away from LIBOR. He added that legal certainty is critical to ensuring that institutions with existing tough legacy contracts can replace their LIBOR benchmark before the end of June 2023, the termination date for all existing LIBOR contracts. Giancarlo then discussed the proposed legislation and urged Congress to consider providing stronger language ensuring that, as institutions are entering into new contracts, they have the clear ability to choose among properly qualified benchmark replacements. He said qualifying factors could include benchmarks meeting the IOSCO standards or benchmarks that are built around market-based trading and fully transparent price discovery. Giancarlo concluded that there is no one-size-fits-all lending benchmark, and that choice among multiple, properly qualified benchmarks not only facilitates the transition away from LIBOR, but also enhances efficiency, reduces systemic risk and encourages economic growth as we progress through the transition process.

Mr. Michael R. Bright, CEO, Structured Finance Association
In his testimony, Bright said absent federal legislation to provide a consistent and fair solution as well as a safe harbor for certain “tough legacy” contracts, retirees and savers will be forced to foot the bill for billions if not tens of billions of dollars in legal costs. Bright identified five key principles of a legislative approach: (1) minimize any value transfer among the contractual parties, (2) use a single, consistent replacement benchmark for all similar LIBOR contracts, (3) minimize litigation risk through a comprehensive but narrow safe harbor, (4) narrowly scope legislation, and (5) do not impact contracts that already have a sufficient replacement mechanism. He concluded by adding that a state-by-state patchwork approach is not viable.

Question & Answer
Need for Federal Legislation
Sens. Bill Haggerty (R-Tenn.) and Brown asked why federal legislation is necessary to fix contracts that do not contain fallback language. Wipf explained the need for clarity to reduce uncertainty for borrowers and issuers and produce a solution for those tough legacy contracts. Pizor expressed concern that industry is paralyzed by litigation risk and said that a safe harbor would be a good inducement to choose SOFR and eliminate risk. He also said states do not have time to pass legislation. Bright said without a federal solution, courts costs will be incurred. Bright added that trustees will need to seek judicial guidance and court costs are lengthy and expensive. Giancarlo said this is one case where federal legislation overriding states’ rights could provide benefits to market participants who need legal certainty and added that the narrow tailoring is important.

Tough Legacy Contracts
Brown asked if there is a risk of acting too slowly to address legacy contracts. Wipf said as market participants see progress on legislation, that leads to good market functioning. Sen. Kyrsten Sinema (D-Ariz.) asked what ambiguities need to be clarified by Congress for tough legacy contracts. Bright said the House-passed legislation does this, and Giancarlo said that in addition to legal certainty for tough legacy contracts, it is important for legislation to make clear that for all other contracts, there is freedom of choice in benchmarks that suit their needs.

LIBOR Liquidity Pitfalls
Toomey asked about the shallowness and narrowness of liquidity and how SOFR and Ameribor avoid these pitfalls. Giancarlo said LIBOR suffered from a failure in liquidity because the trading volume was shallow and there was a limited number of participants in that market. He said many of these qualified benchmarks address a lot of the shortcomings with LIBOR.

SOFR Benefits
Sen. Jack Reed (D-R.I.) asked Wipf how to avoid the past issues of LIBOR in the future. Wipf said SOFR is the most suitable replacement rate for institutions of all sizes and that SOFR is a reliable indicator, is transaction based, and will work in both good times and bad. He added that by having a large data set of transactions, reliance on expert judgement used in LIBOR is removed. Sen. Catherine Cortez Masto (D-Nev.) asked if anyone on the panel does not support the transition to SOFR. Giancarlo stressed that the support of SOFR applies only to legacy contracts and that diversity of choice otherwise is important. Cortez Masto asked Pizor and Wipf if they agreed that banks, institutions, and agencies should have choice of rate. Wipf encouraged market participants to understand whatever reference rate they choose, but that SOFR is the best choice.

Industry Preparedness to Transition
Sinema asked how prepared financial institutions and the industry are to make the transition. Bright said the industry is ready, noted the legacy contract issue is in limbo, and said the safe harbor needs to be included in legislation. Sinema asked how optional character recognition technology will help companies transition from LIBOR to SOFR. Bright said it looks like a helpful tool in identifying what contracts could need legacy help and also pointed to the Chicago Mercantile Exchange and Chicago Board of Options Exchange for their work in preparing markets for the transition.

Consumer Protection
Brown asked Pizor why consumer focused changes to the law are important. Pizor said a safe harbor must only encourage selection of SOFR and not encourage bad actors to try to get extra value and escape liability, taking an opportunity to gouge consumers. He added that NCLC has come to an agreement with industry over the safe harbor. Reed asked what kind of protection Congress and agencies should consider to protect consumers. Pizor said Congress should prioritize fairness in selection of rates and that no one should use that as an opportunity to seek profit.

Sen. Bob Menendez (D-N.J.) asked if a lender could game the transition to charge borrowers higher interest loans. Pizor said yes and that the use of arbitration clauses and class action waivers heighten that risk. Menedez also asked if mandatory arbitration clauses and class action waivers would leave borrowers with no meaningful path to challenge the lenders’ actions. Pizor confirmed and said arbitration is meant to limit opportunities for consumers to challenge misconduct.

Impact on Everyday Americans
Tester asked how LIBOR ending will impact regular people’s lives. Pizor said payments will go up and changes in payments will become more volatile and impact people’s ability to budget. Bright added that it will be confusing for consumers, and Giancarlo said diversity in choice of benchmark is crucial. Tester asked about other potential impacts, such as rates increasing. Wipf said he could not comment, but Bright said efforts are being made to ensure there are no payment or rate shocks.

Student Loans
Menendez asked if the language of private student loan contracts allow private lenders to choose higher rates, increasing costs to borrowers, and how to ensure a fair replacement rate. Pizor said yes and that Congress should offer a safe harbor from litigation inducing investors to choose that particular rate. He added that the end result will work for consumers and that as long as the safe harbor is narrowly tailored, it is the best option. Menendez asked how important it is for the CFPB to finish its guidance to private lenders. Pizor said he hopes the CFPB will release guidance as soon as possible so industry can adapt.

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