Clayton warns muni issuers to not delay Libor transition

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Securities and Exchange Commission Chairman Jay Clayton is warning municipal bond issuers that it’s not advisable for them to bet the proposed phaseout of Libor at the end of 2021 won’t happen as scheduled.

“I would say that playing the it's-not-going-away strategy is a high risk strategy,” Clayton said at a Washington conference sponsored by the Government Finance Officers Association. “You know, the idea that I don't really need to worry about this, because regulators will work it out.”

Clayton described the proposed replacement, the Secured Overnight Financing Rate known as SOFR, as “a good risk free benchmark.”

“Libor is not,” he said, referring to the London interbank offered rate.

Several other conference speakers echoed Clayton’s advice for issuers to not delay their preparations for transitioning away from Libor until nearer the phaseout date.

“If everyone waits until the end of 2021 to come to market, the time may not be advantageous to you,” said Geoff Buswick, a managing director and sector leader in U.S. Public Finance for S&P Global.

Buswick said a delay until near the phase-out deadline carries “a fair amount of credit risk.”

S&P estimates there are 1,400 different municipal bond market issuers with variable-rate debt. “There are many products that are tied to Libor,” Buswick said.

“It’s not something you can start working on in the last six months, said David Bowman, senior associate director of the monetary affairs section of the Board of Governors of the Federal Reserve System. “It is something you need to begin working on now.”

Even if the phaseout doesn’t happen on the proposed date, it could happen soon afterward if the Financial Conduct Authority in the United Kingdom finds that the departure of another major bank from the system has made it a non-representative index.

Meanwhile, SOFR trading has started faster than either the Eurodollar futures of Fed Funds futures, according to a Federal Reserve fact sheet.

Average daily volume has reached about 35,000 contracts of $100 billion with an open interest rate nearing $2 trillion.

And advisory groups have been stepping up with guidance for making the transition away from Libor.

The Governmental Accounting Standards Board proposed in September new accounting and financial reporting guidance to assist state and local governments in the transition away from Libor.

The exposure draft of Replacement of Interbank Offered Rates, which is subject to comments through Nov. 27, proposes removal of all inter-bank offered rates as an appropriate benchmark interest rate effective for reporting periods beginning after Dec. 15, 2020.

The proposal was broadened beyond the London Inter Bank Offered Rate of Libor to include all other IBORs offered in other countries, including Switzerland, Japan and the European Union.

The proposed statement allows governments to continue using hedge accounting for certain hedging derivative instruments that are amended or replaced to change the reference rate from an IBOR.

It also clarifies the hedge accounting termination provisions when an IBOR is replaced as the reference rate of a hedged item and that the uncertainty associated with reference rate reform does not, by itself, affect the probability that an expected transaction will occur.

The proposal adds the Secured Overnight Financing Rate (SOFR) and the Effective Federal Funds Rate as appropriate benchmark interest rates.

It also clarifies the definition of reference rate, and provides an exception to the lease modifications guidance in Statement 87 for certain IBOR-related lease contract amendments.

Ann Battle, assistant general counsel at International Swaps and Derivatives Association, said her organization plans to publish an updated document with the standard terms for a swap contract with all the legal language that can be copied into a loan agreement.

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