[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
THE END OF LIBOR: TRANSITIONING
TO AN ALTERNATIVE INTEREST RATE
CALCULATION FOR MORTGAGES, STUDENT
LOANS, BUSINESS BORROWING, AND
OTHER FINANCIAL PRODUCTS
=======================================================================
VIRTUAL HEARING
BEFORE THE
SUBCOMMITTEE ON INVESTOR PROTECTION,
ENTREPRENEURSHIP, AND CAPITAL MARKETS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
__________
APRIL 15, 2021
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-17
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
44-665 PDF WASHINGTON : 2021
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma
GREGORY W. MEEKS, New York BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri STEVE STIVERS, Ohio
ED PERLMUTTER, Colorado ANN WAGNER, Missouri
JIM A. HIMES, Connecticut ANDY BARR, Kentucky
BILL FOSTER, Illinois ROGER WILLIAMS, Texas
JOYCE BEATTY, Ohio FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER, New Jersey LEE M. ZELDIN, New York
VICENTE GONZALEZ, Texas BARRY LOUDERMILK, Georgia
AL LAWSON, Florida ALEXANDER X. MOONEY, West Virginia
MICHAEL SAN NICOLAS, Guam WARREN DAVIDSON, Ohio
CINDY AXNE, Iowa TED BUDD, North Carolina
SEAN CASTEN, Illinois DAVID KUSTOFF, Tennessee
AYANNA PRESSLEY, Massachusetts TREY HOLLINGSWORTH, Indiana
RITCHIE TORRES, New York ANTHONY GONZALEZ, Ohio
STEPHEN F. LYNCH, Massachusetts JOHN ROSE, Tennessee
ALMA ADAMS, North Carolina BRYAN STEIL, Wisconsin
RASHIDA TLAIB, Michigan LANCE GOODEN, Texas
MADELEINE DEAN, Pennsylvania WILLIAM TIMMONS, South Carolina
ALEXANDRIA OCASIO-CORTEZ, New York VAN TAYLOR, Texas
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
NIKEMA WILLIAMS, Georgia
JAKE AUCHINCLOSS, Massachusetts
Charla Ouertatani, Staff Director
Subcommittee on Investor Protection, Entrepreneurship,
and Capital Markets
BRAD SHERMAN, California, Chairman
CAROLYN B. MALONEY, New York BILL HUIZENGA, Michigan, Ranking
DAVID SCOTT, Georgia Member
JIM A. HIMES, Connecticut STEVE STIVERS, Ohio
BILL FOSTER, Illinois ANN WAGNER, Missouri
GREGORY W. MEEKS, New York FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER. New Jersey ALEXANDER X. MOONEY, West Virginia
VICENTE GONZALEZ, Texas WARREN DAVIDSON, Ohio
MICHAEL SAN NICOLAS, Guam TREY HOLLINGSWORTH, Indiana, Vice
CINDY AXNE, Iowa Ranking Member
SEAN CASTEN, Illinois ANTHONY GONZALEZ, Ohio
EMANUEL CLEAVER, Missouri BRYAN STEIL, Wisconsin
C O N T E N T S
----------
Page
Hearing held on:
April 15, 2021............................................... 1
Appendix:
April 15, 2021............................................... 35
WITNESSES
Thursday, April 15, 2021
Coates, Daniel E., Senior Associate Director, Office of Risk
Analysis and Modeling, Federal Housing Finance Agency (FHFA)... 5
Coates, John, Acting Director, Division of Corporation Finance,
U.S. Securities and Exchange Commission (SEC).................. 7
Smith, Brian, Deputy Assistant Secretary for Federal Finance,
U.S. Department of the Treasury................................ 8
Van Der Weide, Mark, General Counsel, Board of Governors of the
Federal Reserve System......................................... 9
Walsh, Kevin P., Deputy Comptroller, Market Risk Policy, Office
of the Comptroller of the Currency (OCC)....................... 11
APPENDIX
Prepared statements:
Coates, Daniel E............................................. 36
Coates, John................................................. 43
Smith, Brian................................................. 47
Van Der Weide, Mark.......................................... 49
Walsh, Kevin P............................................... 56
Additional Material Submitted for the Record
Sherman, Hon. Brad:
Written statement of the Alternative Reference Rates
Committee (ARRC)........................................... 68
Written statement of the Association for Financial
Professionals et al........................................ 70
Written statement of the Structured Finance Association...... 76
Written statement of the Securities Industry and Financial
Markets Association (SIFMA)................................ 83
Letter from various undersigned organizations................ 95
THE END OF LIBOR: TRANSITIONING
TO AN ALTERNATIVE INTEREST RATE
CALCULATION FOR MORTGAGES, STUDENT
LOANS, BUSINESS BORROWING, AND
OTHER FINANCIAL PRODUCTS
----------
Thursday, April 15, 2021
U.S. House of Representatives,
Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets,
Committee on Financial Services,
Washington, DC
The subcommittee met, pursuant to notice, at 2 p.m., via
Webex, Hon. Brad Sherman [chairman of the subcommittee]
presiding.
Members present: Representatives Sherman, Scott, Himes,
Foster, Meeks, Vargas, Gottheimer, Gonzalez of Texas, San
Nicolas, Axne, Casten, Cleaver; Huizenga, Stivers, Wagner,
Hill, Emmer, Mooney, Davidson, Hollingsworth, Gonzalez of Ohio,
and Steil.
Ex officio present: Representative Waters.
Chairman Sherman. The Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets will come to order.
And live, from Washington, D.C., the Financial Services
Committee's Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets hearing entitled, ``The
End of LIBOR: Transitioning to an Alternative Interest Rate
Calculation for Mortgages, Student Loans, Business Borrowing,
and Other Financial Products.''
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time. Also, without
objection, members of the full Financial Services Committee who
are not members of this subcommittee are authorized to
participate in today's hearing.
As a reminder, I ask all Members to keep themselves muted
when they are not being recognized by the Chair. The staff has
been instructed not to mute Members except when the Member is
not being recognized by the Chair and there is inadvertent
background noise.
Members are reminded that they may only participate in one
remote proceeding at a time. If you are participating today,
please keep your camera on. If you choose to attend another
remote proceeding, please turn your camera off.
I will now recognize myself for a 4-minute opening
statement, after which we will hear from Ranking Member
Huizenga.
In a way, this is a test to see whether Congress can pass
necessary legislation that is not Democratic, and is not
Republican. There are $200 trillion of business loans, of home
mortgages, and of other instruments that have adjustable
interest rates that are keyed to the London Interbank Offered
Rate (LIBOR). As of January of next year, two of the minor
London Interbank Rates will no longer be published. And as of
June of next year, none of the London Interbank Rates will be
published.
You start with $200 trillion of instruments. Ninety-nine
percent of the problem we do not have to deal with because many
of these instruments are short term and they will expire before
next year. And a lot of these instruments were drafted with the
foresight to recognize that there is a possibility that the
London Interbank Rate would not be published, and the parties
have agreed what to do under those circumstances.
So, we are dealing with a mere 1 percent. But that mere 1
percent is $2 trillion of instruments. These instruments were
drafted and the parties agreed without anticipating that LIBOR
would no longer be published during the term.
Now, I do not want to minimize this. This is still $2
trillion. Chair Powell of the Federal Reserve has told us that
this is a systemic risk to our entire economy. And in the last
2 months, both the Chair of the Fed and the Secretary of the
Treasury have testified before our committee, saying that
Federal legislation is necessary.
What Federal legislation? There is a bill in Albany, New
York. I have circulated draft number 1, and just this week, I
circulated to members of the committee discussion draft number
2. These bills are substantively identical, and we are still
fine-tuning the drafting, and I look forward--I am glad that
Mr. Huizenga has agreed to work with me on that final drafting,
and I look forward to working with him to get this bill
adopted.
Some 30 organizations have written to our committee saying
that we need legislation along the lines of these discussion
drafts. Now, these are groups that do not always agree.
Supporting this approach are the Americans for Financial
Reform, the National Consumer Law Center, the U.S. Chamber of
Commerce, the Structured Finance Association, and SIFMA.
Finally, you might ask, well, why not just have the States
do it? There are five reasons: first, some States will not do
it.
Second, you get into choice-of-law litigation where you may
have the borrower in one State, the lender in a second State,
and the security for the loan is in a third State. If they have
different rules, different amounts to be paid, we can litigate
instrument by instrument, which is not an efficient approach.
Third, we would leave our lenders with 51 different systems
to deal with, which is expensive and unnecessary.
Fourth, no State has jurisdiction where the Trust Indenture
Act of 1939 is applicable. So, even if we got all 51 States to
act, and even if they were consistent, we would still be
leaving hundreds of billions of dollars outside the solution.
And finally, some instruments are, in effect, in two
levels. You may have a mortgage-backed security subject to New
York law, which is an investment in a pool of mortgages which
are subject to 50 different State laws depending upon where the
home is located.
We need Federal legislation, and I look forward to working
with the members of this committee to achieve it. And we need
to act soon because the legislation drafts have regulators
having to adopt regulations, and that will take some time as
well, and we have to get it all done this year.
With that, I recognize the ranking member of the
subcommittee, Mr. Huizenga, for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman. I do appreciate you
having this hearing. As you have pointed out, as of late, we
have heard from some of those regulators who have acknowledged
the need for a Federal approach. They had not been so
enthusiastic about that until more recently. And as you
indicated, this is not necessarily a Democrat or a Republican
issue, but I will note that it does need to be open to input.
So, there is no party attached to this, but there is a need for
input on it.
I am going to skip over some of my remarks because I know
that time is going to be short here. But as you pointed out,
when we have over $223 trillion, with a ``T''--which, by the
way, is even more than what we have been spending lately--that
is a huge amount of money. And when we have that, these
exposures that are in derivatives, corporate bonds, business
loans, secured products, commercial and residential mortgage
loans, credit cards, student loans, auto loans--a lot of things
are tied to LIBOR, and obviously, to date, we saw with the
London Whale that there has now been $9 billion in fines that
have been levied here and in the U.K., in the European Union.
There is a lot of agreement that this was a benchmark that
could not continue. And there have been comprehensive reforms
which include designating a new lead regulator for LIBOR, in
addition to new governance and oversight technology for the
benchmark. However, despite these reform efforts in both the
U.S. and the U.K., ``LIBOR has increasingly relied on market
and transaction database expert judgment.''
So in response to the recommendations and objectives set
forth by the Financial Stability Board (FSB) and the Financial
Stability Oversight Council (FSOC), and to address continued
risks related to the U.S. Dollar LIBOR, the Federal Reserve
Board and the Federal Reserve Bank in New York jointly convened
the Alternative Reference Rates Committee (ARRC) in 2014. ARRC
was tasked to identify, ``risk-free alternative reference rates
for U.S. Dollar LIBOR, identify best practices for contract
robustness, and to create an implementation plan with metrics
of success and a timeline to support an orderly adoption.''
That is, I think, all good. In 2017, ARRC announced the
Secured Overnight Financing Rate, or SOFR, its recommended
alternative to the LIBOR. SOFR is an overnight interest rate
based on Treasury repurchase transactions or overnight
corporate loans secured by U.S. Treasury securities. Unlike
LIBOR, SOFR is calculated based on interest rates charged in
real transactions in the U.S. Treasury repo market.
One of the biggest challenges that we have with
transitioning away from LIBOR is the thousands of existing
legacy contracts that extend beyond 2023 that reference LIBOR
but do not contain contractual, ``fallback language,'' that
allows for the contract to be amended, and continue to function
should LIBOR be discontinued. That is as of the fourth quarter
of 2020.
There are $223 trillion of outstanding exposures to U.S.
Dollar LIBOR--$74 trillion in contractual notional value will
remain outstanding after LIBOR's discontinuation in June of
2023, and this includes approximately $69 trillion in
derivatives and approximately $5 trillion in cash products.
Some of these parties have begun incorporating fallback
provisions, but it looks like, as we transition away, slowly
transition away, both Treasury and Federal Reserve officials
have called now for Federal legislation to assist in the smooth
transition.
I am looking forward to hearing from the witnesses today.
Mr. Chairman, we do need to work on this together, with the
input not only of industry and those who are affected, but
those of us who have been elected to act as that speed bump at
times to make sure that we are heading in the right direction,
and I for one want to make sure that the Federal Reserve, not
just the New York Fed but the Federal Reserve, it seems to me,
may need to have a piece of this rather than just being the New
York Federal Reserve, and we need to make sure that any Federal
legislation provides market stability and preserves market
liquidity.
I think my time is expiring, but I do look forward to
working with you in a cooperative manner, and I yield back.
Chairman Sherman. I could not agree with you more--a
trillion dollars here, and a trillion dollars there, can add up
to real money.
I now recognize the Chair of the full Financial Services
Committee, the gentlewoman from California, Chairwoman Waters,
for 1 minute.
Chairwoman Waters. Thank you so very much, Chair Sherman.
You have been talking about LIBOR to anybody who would listen
to you for over a year or so now, maybe longer than that, and I
am so pleased that you are holding this hearing.
Trillions of dollars of consumer contracts, ranging from
mortgages and student loans to securities contracts, are
currently tied to the LIBOR, which will cease as a reference
rate in 2023. As a result, these contracts will have to use
another rate.
LIBOR proved to be easily manipulated when banking
authorities around the globe found extensive collusion by
megabanks like JPMorgan, Citigroup, Barclays, Deutsche Bank,
UBS, and the Royal Bank of Scotland, to fix the LIBOR to their
own advantage. These institutions paid billions of dollars in
fines to settle their fraud, but now we need to protect
consumers, investors, and the U.S. financial system as the
markets transition away from the LIBOR.
Thank you, and I yield back the remainder of my time.
Chairman Sherman. Thank you, Madam Chairwoman.
Today, we welcome the testimony of our distinguished
witnesses.
First, we have Dan Coates, who is the Senior Associate
Director for the Office of Risk Analysis and Modeling at the
Federal Housing Finance Agency (FHFA).
Our second witness will prove that our subcommittee can
attract more Coates than any other subcommittee this week. We
have John Coates, no relation, who is the Acting Director of
the Division of Corporation Finance at the U.S. Securities and
Exchange Commission (SEC).
Our third witness will be Brian Smith, who is the Deputy
Assistant Secretary for Federal Finance at the U.S. Department
of the Treasury.
Our fourth witness will be Mark Van Der Weide, who is the
General Counsel at the Board of Governors of the Federal
Reserve System. And I want to thank Mr. Van Der Weide for his
help in drafting what is now discussion draft 2, which I have
circulated this week.
And finally, we will have Kevin Walsh, who is the Deputy
Comptroller for Market Risk Policy at the Office of the
Comptroller of the Currency.
The witnesses are reminded that your oral testimony will be
limited to 5 minutes. You will be able to see a timer on your
screen that will indicate how much time you have left, and a
chime will go off at the end of your time. I would ask that you
be mindful of the timer and quickly wrap up your testimony if
you hear the chime so that we can be respectful of both the
witnesses' and the committee members' time. And without
objection, your full written statements will be made a part of
the record.
I now recognize Mr. Dan Coates for 5 minutes.
STATEMENT OF DANIEL E. COATES, SENIOR ASSOCIATE DIRECTOR,
OFFICE OF RISK ANALYSIS AND MODELING, FEDERAL HOUSING FINANCE
AGENCY (FHFA)
Mr. Dan Coates. Good afternoon, Chairwoman Waters, Chairman
Sherman, Ranking Member Huizenga, and members of the
subcommittee. I appreciate the opportunity to testify before
you today.
I serve as the Senior Associate Director of Risk Analysis
and Modeling in the Federal Housing Finance Agency's Division
of Federal Home Loan Bank Regulation.
FHFA regulates and oversees Fannie Mae, Freddie Mac, and
the Federal Home Loan Bank System. Since 2008, FHFA has also
served as conservator of Fannie Mae and Freddie Mac--together,
the Enterprises.
Since completing my Ph.D. in economics, I have served in
the Federal Government for over 30 years. Today marks the first
time I am testifying before Congress.
At FHFA, I lead an office of economists and financial
analysts supporting our examination, supervision, and
regulation of the Federal Home Loan Banks. Since the 2017
announcement of LIBOR's future discontinuation, I have lead
FHFA's LIBOR transition efforts as it oversees the transition
of its regulated entities.
LIBOR has been the world's most widely used interest rate
benchmark. Preparing for this transition has been and will
continue to be an enormous undertaking, with a variety of
implications for all participants in the global financial
system.
FHFA and its regulated entities have been leaders in this
effort, and I am proud of what we have accomplished to date. As
Director Calabria has made clear, FHFA's efforts to transition
away from LIBOR are guided by the same core principles that
direct all of the agency's work: ensuring the safety and
soundness of our regulated entities; supporting liquidity and
resilience in our nation's housing finance markets; and
protecting homeowners and renters.
While important work remains, I am confident that we will
meet our goal of fully transitioning the Enterprises and the
Federal Home Loan Banks away from LIBOR before the end of 2021.
When this effort began, LIBOR was the reference rate for the
vast majority of financial products central to the operations
of FHFA's regulated entities. Such products included Enterprise
and Federal Home Loan Bank System debt, Federal Home Loan Bank
advances, derivatives transactions, mortgage-backed securities,
collateralized mortgage obligations, credit risk transfer
transactions, and adjustable rate mortgages, known as ARMs.
Our challenge was to ensure our regulated entities
transitioned to robust reference rates for all of these
products, and for the related internal systems of the regulated
entities. FHFA supports, and its regulated entities have
adopted, the ARRC's recommended replacement rate as being the
best suited for this transition away from LIBOR.
There are a number of contracts that did not contemplate
the permanent cessation of LIBOR. Disputes over the
interpretation of these contracts will likely be lessened with
the passage of Federal legislation to provide clarity about the
transition.
While FHFA is open to any robust reference rate that meets
the principles of the International Organization of Securities
Commissions and its fit for purpose, the time remaining to
prepare for this transition is getting short, and FHFA does not
support a wait-and-see approach to this transition.
While the date of the LIBOR cessation has recently been
extended for most U.S. Dollar LIBOR maturities until June 30th,
2023, FHFA has continued to ensure that our regulated entities
are ready for the LIBOR cessation by the end of this year. The
actions FHFA has taken since 2018 to prepare for this
transition are consistent with the guidance issued on November
30, 2020, by the Federal Reserve, the OCC, and the FDIC, who
stated their concerns that continued LIBOR use after the end of
2021 would create safety and soundness risks.
Thanks to FHFA's leadership, the Federal Home Loan Banks
and the Enterprises are moving prudently away from LIBOR. As of
July 2020, the Federal Home Loan Banks have ceased entering
into LIBOR transactions with maturities beyond 2021. As of
December 31, 2020, the Enterprises are no longer purchasing
LIBOR-indexed ARMs or issuing any LIBOR-based mortgage
products. They are now purchasing SOFR-based ARMs and issuing
SOFR-indexed mortgage-backed securities and other market
products.
FHFA's regulated entities have led the LIBOR transition as
the first and most significant issuers of SOFR-indexed debt and
as developers of SOFR-based alternatives to their existing
LIBOR products. At FHFA, we continue to look for ways we can
enhance awareness of the importance of this transition.
I will be glad to answer your questions.
[The prepared statement of Senior Associate Director Daniel
Coates can be found on page 36 of the appendix.]
Chairman Sherman. Thank you, Mr. Coates.
We now recognize Mr. John Coates for 5 minutes.
STATEMENT OF JOHN COATES, ACTING DIRECTOR, DIVISION OF
CORPORATION FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION
(SEC)
Mr. John Coates. Thank you, Chairwoman Waters, Chairman
Sherman, Ranking Member Huizenga, and members of the
subcommittee. I appreciate the opportunity to testify today
about the transition away from LIBOR and the efforts of the
staff of the Securities and Exchange Commission to monitor that
transition in furtherance of the Commission's missions, which
are to protect investors, maintain fair and orderly markets,
and facilitate capital formation.
The announced discontinuation of LIBOR and the transition
to one or more alternatives will have significant impacts on
the financial markets and on market participants, and it may
present material risks for both public companies and their
investors, as well as SEC-supervised entities. Those risks will
be greater if an orderly transition is not completed in a
timely manner, including important work to be done this year
and beyond.
A cross-agency team of staff at the Commission has been
collaborating regularly on transition matters, and the staff is
actively monitoring the extent to which market participants are
identifying and addressing risks in preparing for the
transition.
In the division that I currently help lead, the Division of
Corporation Finance, we have been encouraging public companies
to plan for the transition and consider their disclosure
obligations and the risks that the transition may present to
their businesses. We specifically encourage companies to inform
investors about risk identification and mitigation, as well as
any anticipated material impacts of the transition which may
particularly affect companies who face financing constraints.
Companies may also need to reflect the transition in their
information technology systems, their internal controls, and
their policies and procedures. The back office, which sometimes
gets neglected, is going to be very important in this
transition.
A second division at the SEC, our Trading and Markets
Division, has been monitoring the impacts of the transition on
brokers, counterparties, and exchanges. These impacts may arise
due to being a party to transactions referencing LIBOR, making
a market in those instruments, underwriting, placing, or
advising on them. And the impact can have several different
channels for how they affect these firms, on their businesses
and systems. Valuation models are going to have to be changed,
business processes used, and risk management frameworks.
Ultimately, these firms serve clients who also are going to be
affected.
A third division at the SEC, our Examinations Division, has
been assessing the impact on entities that we oversee. Last
year, we performed roughly 75 exams on a wide range of
registrants, with a focus on identifying challenges from the
transition. They have also provided guidance for how to plan
for and carry out a successful transition. And as with our
other efforts, that exam work is ongoing.
Preparation in risk management by investment advisors and
funds is performed by our Division of Investment Management.
That division has been encouraging advisors to consider the
effect of the transition on LIBOR-based instruments which are
held by mutual funds, which are in turn held by millions of
retail investors. Investment Management has been providing
guidance to encourage funds to provide tailored disclosures
about the transition and how it interacts with their investment
objectives, holdings, strategies, and structure.
Finally, two of our offices have been also involved in
LIBOR-related work, our Office of the Chief Accountant and our
Office of Municipal Securities. Let me just say it is nice to
be testifying before a Chair who has an accounting background,
which is a central focus of my division. Our Chief Accountant
continues to monitor the activities of preparers and auditors,
standard setters and other regulators to address the financial
reporting issues related to the transition. The staff of the
Chief Accountant has been having ongoing discussions with
various stakeholders and has supported efforts to raise
awareness of the accounting side of the transition, and we note
that the Financial Accounting Standards Board (FASB) and the
International Accounting Standards Board (IASB) have continued
to update their standards to reflect ongoing changes throughout
the transition.
Last but not least, our Office of Municipal Securities has
been encouraging municipal issuers and advisors to focus on
those issues directly relevant to the municipal market, which
is also important to retail.
Thank you for the opportunity to testify here today.
[The prepared statement of Acting Director John Coates can
be found on page 43 of the appendix.]
Chairman Sherman. I thank our witnesses for limiting their
comments to 5 minutes.
We now recognize Mr. Smith for 5 minutes.
STATEMENT OF BRIAN SMITH, DEPUTY ASSISTANT SECRETARY FOR
FEDERAL FINANCE, U.S. DEPARTMENT OF THE TREASURY
Mr. Smith. Thank you to Chairwoman Waters, Chairman
Sherman, and Ranking Member Huizenga. I appreciate the
opportunity to testify at this hearing on this important issue.
As Treasury's Deputy Assistant Secretary for Federal
Finance, I oversee the Department's work on the LIBOR
transition.
Though LIBOR is used in more than $200 trillion of
outstanding financial contracts today, 2 tenors of USD LIBOR
will cease being published at the end of 2021, and the
remainder will cease by June 2023. LIBOR's widespread use in
the financial system, but short remaining lifespan, underscores
the urgency of a timely and effective transition.
In recent years, Treasury has played an active role in
highlighting the risks associated with the continued use of
LIBOR and encouraging a market participant-led transition.
Since 2013, annual reports of the Financial Stability Oversight
Council (FSOC), which the Treasury Secretary chairs, have
called attention to LIBOR-related financial stability risks,
encouraged market participants to formulate and execute their
transition plans, and recommended that member agencies use
their authorities to facilitate transition.
Treasury has served as an ex-officio member of the
Alternative Reference Rates Committee, or ARRC, since that
group was convened in 2014 by the Board of Governors of the
Federal Reserve System and the Federal Reserve Bank of New
York. The ARRC is composed of a diverse set of private market
participants working towards successful transition away from
LIBOR. As an alternative to LIBOR, the ARRC has recommended the
Secured Overnight Financing Rate, or SOFR, which is a robust
rate based on nearly $1 trillion in daily transactions. The
ARRC has also recommended robust contract fallback language for
various financial products and has worked closely with
regulators to identify and tackle potential roadblocks to
transition.
Treasury applauds the passage of LIBOR transition
legislation in New York State, which will provide meaningful
relief for the transition of legacy contracts written under New
York law. In addition, Treasury has also taken initial steps to
address the potential tax consequences of modifying contracts
that reference LIBOR, although some of the relevant tax
statutes lack a grant of regulatory authority, which limits the
tax relief that Treasury can provide.
Despite this important progress, challenges for the
transition remain, and Federal legislation is needed. As
Secretary Yellen described in recent testimony before the House
Financial Services Committee, legislation is necessary for so-
called, ``tough legacy'' contracts that do not specify a
workable fallback rate and are not feasible for private-sector
actors to modify on their own. Federal legislation could also
ensure that Treasury has sufficient authority to address the
tax consequences of the LIBOR transition and amend the Higher
Education Act of 1965's reference to LIBOR for special
allowance payments under the legacy guaranteed Federal student
loan program.
With LIBOR's cessation dates approaching quickly, market
participants must make progress on transitioning contracts,
where feasible, and new contracts should begin referencing
alternative rates like SOFR. In addition, in the case of
consumer loans, it is imperative that lenders engage with
consumers about how this transition will affect them and
provide them with timely notice of any changes. Lenders need to
act responsibly so that consumers are not caught by surprise.
With that, I will conclude my remarks. Chairman Sherman and
Ranking Member Huizenga, thank you again for your interest and
your engagement on this important issue, and I look forward to
your questions.
[The prepared statement of Deputy Assistant Secretary Smith
can be found on page 47 of the appendix.]
Chairman Sherman. Thank you for your brevity.
I now recognize Mr. Van Der Weide, and I want to thank Mr.
Van Der Weide for his help in drafting the session draft number
2. You are recognized for 5 minutes.
STATEMENT OF MARK VAN DER WEIDE, GENERAL COUNSEL, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Van Der Weide. Chairman Sherman, Ranking Member
Huizenga, and members of the subcommittee, thank you for the
opportunity to appear today. My testimony will discuss the
importance of ensuring a smooth, transparent, and fair
transition away from LIBOR to more durable replacement rates,
as well as some of the challenges posed by this transition.
Before I delve into these issues, however, it may be helpful to
review how LIBOR is used and why it will be discontinued.
LIBOR measures the average interest rate at which large
banks can borrow in unsecured wholesale funding markets. Over
the past few decades, LIBOR became a benchmark used to set
interest rates for commercial loans, mortgages, derivatives,
and many other financial products. In total, U.S. Dollar LIBOR
is used in more than $200 trillion of financial contracts
worldwide.
By now, the flaws of LIBOR are well documented. A
fundamental deficiency is that LIBOR has been based on thinly
traded markets, which has made the rate vulnerable to collusion
and manipulation. Following the exposure of these weaknesses
and the imposition of material large legal penalties on a
number of firms and individuals that engaged in LIBOR
misconduct, most of the LIBOR banks determined that they would
not continue making LIBOR submissions.
Last month, LIBOR's U.K. regulator announced that the one-
week and two-month U.S. Dollar LIBOR rates will cease to be
published at the end of 2021, while the remaining LIBOR rates
will cease to be published on a representative basis in mid-
2023. This definitive announcement about the end of LIBOR
underscores the importance of moving away from this moribund
benchmark rate.
Market participants, regulatory agencies, consumer groups,
and other stakeholders have put in a great deal of work to
prepare for life after LIBOR. To promote a smooth transition
away from the rate, the Central Reserve convened the
Alternative Reference Rate Committee, or ARRC, in 2014.
Recognizing that the private sector must drive the transition,
the ARRC's voting members are private-sector firms.
In 2017, the ARRC identified Secured Overnight Financing
Rate, or SOFR, as its recommended alternative to U.S. Dollar
LIBOR. SOFR is a broad measure of the cost of borrowing cash
overnight, collateralized by Treasury securities. Unlike LIBOR,
SOFR is based on a market of high-volume underlying
transactions, regularly around $1 trillion daily.
Market participants are not required to replace LIBOR with
SOFR for financial contracts. Importantly, the Federal Reserve
and the other regulatory agencies issued a statement last year
to emphasize that a bank may use any reference rate for its
loans that the bank determines to be appropriate for its
funding model and customer needs. They also noted, however,
that a bench loan contract should include robust callback
language.
The Fed's supervision of LIBOR is strengthening. In
November of 2020 the Federal Reserve, the OCC, and the FDIC
sent a letter to banking firms noting that the continued use of
U.S. Dollar LIBOR in new transactions after 2021 will create
safety and soundness risks. Accordingly, we have encouraged our
supervised entities to stop using LIBOR in new contracts as
soon as practicable, or in any event, by the end of this year.
Vice Chair Quarles emphasized in a recent speech that
banking firms should be aware of the intense supervisory focus
the Fed is placing on the LIBOR transition.
A key question for policymakers is whether legacy LIBOR
contracts can seamlessly switch over to alternative reference
rates when LIBOR ends. The ARRC recently estimated that roughly
one-third of legacy contracts will not mature before mid-2023.
Some of these legacy contracts have workable fallback language
to address the end of LIBOR, but others do not, which may
result in significant litigation.
Chair Powell and Vice Chair Quarles have publicly stated
their support for Federal legislation to mitigate risks related
to legacy contracts. Federal legislation would establish a
clear and uniform framework on a nationwide basis for replacing
LIBOR in legacy contracts that do not provide for an
appropriate fallback rate.
Federal legislation should be targeted narrowly to address
legacy contracts that have no fallback language, that have
fallback language referring to LIBOR or to a poll of banks, or
that effectively convert to fixed-rate instruments.
Federal legislation should not affect legacy contracts with
fallbacks to another floating rate, nor should Federal
legislation dictate that market participants must use any
particular benchmark rate in future contracts.
Finally, to avoid conflict-of-laws problems, Federal
legislation should preempt any outstanding State laws on legacy
LIBOR contracts.
Thank you. I look forward to your questions on this
important matter.
[The prepared statement of Mr. Van Der Weide can be found
on page 49 of the appendix.]
Chairman Sherman. Thank you.
Mr. Walsh is now recognized for 5 minutes.
STATEMENT OF KEVIN P. WALSH, DEPUTY COMPTROLLER, MARKET RISK
POLICY, OFFICE OF THE COMPTROLLER OF THE CURRENCY (OCC)
Mr. Walsh. Chairwoman Waters, Chairman Sherman, Ranking
Member Huizenga, and members of the subcommittee, thank you for
the opportunity to discuss the OCC's work to ensure the large,
mid-sized, and community banks we supervise are prepared for
the cessation and replacement of the London Interbank Offered
Rate, or LIBOR.
I am Kevin Walsh, Deputy Comptroller for Market Risk
Policy. I am the OCC's ex-officio member of the Alternative
Reference Rate Committee, I oversee the agency's representation
on other committees associated with LIBOR cessation, and I
oversee the development and interpretation of policy and
guidance related to market risk facing the Federal banking
system.
The OCC has worked closely with the institutions we
supervise to ensure their preparedness since 2018. To avoid the
risk of market disruptions, prolonged litigation, and adverse
financial impacts, the OCC has stressed to banks we supervise
the importance of adequate transition planning and successfully
executing those plans before LIBOR ceases to be reported.
The OCC's mission is to ensure that the institutions we
charter and supervise operate in a safe and sound manner and
treat all customers fairly. Rather than endorse any specific
replacement rate, including the Secured Overnight Financing
Rate (SOFR), we want to ensure that banks have the flexibility
to determine LIBOR's successor rate or rates as may be most
appropriate for the continued operation of their business model
and risk appetite and the function that rate supports in a safe
and sound manner.
Starting in 2018, as part of our ongoing outreach sessions
with bank CEOs, CFOs, chief risk officers, and bank directors,
we included discussions of LIBOR cessation and encouraged them
to consider their exposures, risk tolerances, and mitigation
plans. We first mentioned the need for LIBOR transition plans
in our semi-annual risk perspective that year. Since then we
have published several bulletins and guidance documents that
set forth our expectations for bank transition activities.
In November 2020, the OCC published a joint letter with the
Federal Reserve and the FDIC which reiterated that a bank may
use any reference rate it determines to be appropriate for its
business model and customer needs. That month, the OCC and
other banking regulators clarified expectations that banks must
stop creating new LIBOR exposures by the end of 2021, with few
exceptions. Recently, the OCC published a self-assessment tool
that includes a series of questions related to bank exposure
assessment and planning, consideration of replacement rates,
fallback language, and the bank's overall LIBOR cessation
preparedness. The tool helped bank management evaluate,
identify, and alleviate transition risks. To date, more than 95
percent of the institutions we supervise have gone through the
process to quantify their exposures.
For smaller community banks that engage in LIBOR-based
lending, such as commercial or residential real estate lending
or small business loans, the transition process may present
operational challenges that banks will need to address based on
their resources, the scope of their exposure, and the relative
financial sophistication of their borrowers. The OCC is working
closely with these banks to assist them in mitigating these
challenges.
OCC examiners are also supporting the regional and largest
banks to address their LIBOR-based exposures and are actively
monitoring the adequacy of their planning and implementation of
their mitigation strategies. My testimony describes how new
International Swaps and Derivatives Association (ISDA)
protocols in a recently enacted New York State law have
significantly reduced the risk of market disruption in the
derivatives market.
Mitigating risks within consumer loan products and
securities portfolios will be more complex, given the nature of
those instruments. Loans are typically negotiated between
parties, and the applicability of a variety of State laws can
make negotiations more complicated. Securities, notably
securitized exposures, are complicated by the diverse investor
bases that need to provide agreement to make changes to the
rates. Banks continue to work on preparing these portfolios for
the transition, and the OCC is closely monitoring their
efforts.
To further assist with the transition, the OCC appreciates
Congress' efforts to clarify contracts that do not have a
fallback provision or new rate as is designated in the draft
Adjustable Interest Rate LIBOR Act of 2021. Legislation could
be helpful in addressing systemic risks associated with the
LIBOR cessation by incentivizing financial counterparties to
agree to an appropriate reference rate or otherwise designating
SOFR as the replacement rate. The OCC has provided comments to
staff and looks forward to working with the subcommittee to
perfect the legislation.
Thank you again for inviting me to appear today. I will be
happy to answer your questions.
[The prepared statement of Deputy Comptroller Walsh can be
found on page 56 of the appendix.]
Chairman Sherman. Thank you.
We will be conducting this hearing while there is voting
going on, on the Floor. I have been told that Mr. Casten will
be back within 10 minutes, which will give me a chance to rush
to the Floor to vote.
Mr. Huizenga. Mr. Chairman, this is Bill Huizenga. Just a
point of clarification, you do not intend to halt the hearing,
correct? You are just expecting this to go on, on an ongoing
rolling basis, correct?
Chairman Sherman. Exactly. Out of respect for our
witnesses' time, I am hoping that members can vote and come
back and that they will be available when they are called on,
and if they are not, we will go on to the next member from the
respective party.
Mr. Huizenga. And is there any indication--I know that
recently votes were changed to a 30-minute window, and I know
we have 14 votes today. Are we anticipating that those will
continue to be 30-minute votes for each one of those, or are
you aware of leadership taking up that time, which may make
this a little more challenging to do this on an ongoing rolling
basis?
Chairman Sherman. The rules are 30 minutes. In the past,
they have been 40 minutes. My guess is that 30 today will mean
30, but there is no change in the official policy.
Mr. Huizenga. Okay. Thank you.
Chairman Sherman. And I will remind members that the tape
of this hearing will be available. So if you miss part of it,
you can go back and watch it late tonight, or you can watch it
while we are waiting for the 13th and 14th vote later in the
evening.
I will now yield myself 5 minutes.
I want to thank Mr. Van Der Weide for pointing out that the
discussion drafts honor the sanctity of contracts with the 90
percent-plus contracts that were written in anticipation of the
possibility that LIBOR would no longer be published, and that
these discussion drafts involve inserting government only where
the parties did not make an agreement that can be carried out.
I want to thank Mr. Walsh for pointing out the operational
challenges that will face, particularly small and medium-sized
institutions. If we end up with 51 different rules, small banks
that may not do business in the District of Columbia and all 50
States, but may have loans on their books for one reason or
another in 5 or 10 different places, could easily find
themselves facing real operational difficulties.
I now have a question for each one of our witnesses that I
am hoping to get a simple yes or no answer to, and I will go
down the list. The question is, is it important that we
promptly adopt Federal legislation to provide a statutory fix
for LIBOR-based contracts that lack sufficient background
language?
Mr. Dan Coates, is it important?
Mr. Dan Coates. Yes. Yes, we believe it is important.
Chairman Sherman. Mr. John Coates?
Mr. John Coates. The Commission has not taken a position
formally on legislation, but we are supportive of efforts to
increase the stability of the market, so we stand ready to
support your efforts in this legislation.
Chairman Sherman. That is as close to a yes as you can get
until the new Chair takes over.
Mr. Smith?
Mr. Smith. Yes. Secretary Yellen has indicated support for
the Federal legislation.
Chairman Sherman. Mr. Van Der Weide?
Mr. Van Der Weide. Yes, thumbs up.
Chairman Sherman. And Mr. Walsh?
Mr. Walsh. We think it is constructive.
Chairman Sherman. Thank you.
Mr. John Coates, in the absence of a clear solution for
LIBOR-based contracts as we get closer to June 2023, I imagine
we are going to see increased price volatility or a discounting
of those instruments that lack clear fallback language. Is that
something that we would expect, where two contracts that look
identical will be trading differently because one has
significant fallback language in it but the other one does not?
Mr. John Coates. I think that is a fair prediction. I think
any risks, including litigation risk, can affect pricing and
could create discrepancies in pricing. I think that is correct.
Chairman Sherman. Now, Mr. Van Der Weide, I have a question
for you about timing. Each proposal, whether it is the one from
Albany or the two that I have circulated, all involve the idea
of an agency writing a regulation. So first you need the
legislation, and then, you get the regulatory process. So how
much time do we have to adopt legislation and have it signed
into law, so that the Fed can adopt regulations that will solve
this problem?
Mr. Van Der Weide. I think it is important that we have a
regulatory agency with the ability to write regulations to
implement the legislation. There are going to be a lot of
complicated operational issues, and it will be useful to have
an agency that can do the interstitial work to plug those
holes. That does mean I think it is important for Congress to
act expeditiously to get the legislation passed. I do not have
a deadline to give you, but as you know, the important LIBOR
tenors are going to be going away in mid-2023. We will want to
give an agency some time to write the rules, so, decently well
in advance of June 2023, we want Congress to have that
legislation passed.
Chairman Sherman. My staff calculated that you need 240
days to adopt regulations. Is that right, or can you do it more
quickly? Or optimally, would you have 240 days, or how much
less could you live with?
Mr. Van Der Weide. Optimally, yes, I think that having 8
months would be great, but we can do it a little faster than
that. I am sure we can do it a little faster than that.
Chairman Sherman. Okay. Well, my hope is that we have this
signed into law, hopefully before Halloween. Otherwise, it
starts to get scary for financial markets.
My time has expired. I will now recognize Mr. Huizenga for
questions.
Mr. Huizenga. Thank you, Mr. Chairman.
I want to start with my fellow Dutchman. Being Chair of the
Dutch Caucus, this is an important clarification, whether it is
``Van Der Weide,'' as we would say in West Michigan, or ``Van
Der Weide.'' Feel free to clarify.
But I do have a question for you. Does the New York State
legislation only fix New York problems, or does it impact some
of those other contracts across the country? And what happens
in the absence of any Federal intervention?
You are on mute. Sorry, we need you to come off mute. We
still cannot hear you, sir.
Mr. Chairman, I am hoping we will be able to add a little
time back onto the clock.
Chairman Sherman. We will add 20 seconds back.
Mr. Huizenga. It was about 40 seconds.
Chairman Sherman. We will add 45 seconds back.
Mr. Huizenga. Whatever.
Chairman Sherman. Which means you now have more than 5
minutes. Go on.
Mr. Huizenga. Okay. If he is speaking, I am sorry, but I
cannot hear him.
Chairman Sherman. Neither can I.
Mr. Huizenga. Let me move on, and hopefully we will be able
to get back to you, Mr. Van Der Weide, for that clarification
on your name pronunciation.
But to everybody, I guess, the question that the chairman
asked, I think is a good one. In your support of this, is it
this specific language that we have before us, or is it the
concept of Federal legislation needing a response?
Why don't we start off with the two Mr. Coates?
Mr. Dan Coates. Congressman, we support any Federal
legislation to smooth the transition. We stand ready to help
you and your colleagues.
Mr. Huizenga. So it is more the concept that we need to
address it.
Mr. Dan Coates. Yes, sir.
Mr. Huizenga. Correct. Okay.
Mr. John Coates?
Mr. John Coates. Yes, thank you. The same answer as before,
which is we are supportive of efforts to increase the stability
of the markets, and that applies regardless of the particular
language.
Mr. Huizenga. Okay. And, Mr. Walsh, I detected a hint of a
little more reticence on your part. I do not know whether that
was intentional or me reading into it, but the question I have
for you is, is the concept for the need for Federal legislation
or this specific language? And then, do you perceive any
conflict in using SOFR?
Mr. Walsh. To answer the first part of your question,
Congressman, we think that the Federal legislation is very
constructive and we have offered comments to staff and would be
very happy to review those comments with staff and work to
perfect the legislation, moving forward.
No, we do not see that there is any issue or problem with
SOFR, but the scope and spectrum of banks that the OCC
supervises is extraordinarily diverse, from the largest
globally active, most complex financial institutions down to
small community banks that operate in a very local way, and
their needs are different. We want to respect that and give
them the opportunity to use any replacement rate that they
think fits their business model, their risk appetite, and is
appropriately approved through their internal processes for
risk management.
Mr. Huizenga. So let me ask you, what happens in the
absence of Federal intervention?
Mr. Walsh. I think that in the absence of Federal
legislation, the contracts that do not have fallback language
can be very problematic, and there are also a large number of
contracts that require 100 percent of investor-based agreement
that we do not think is operationally executable.
Mr. Huizenga. Is the shorthand to that answer, litigation?
Mr. Walsh. Yes.
Mr. Huizenga. Okay. On preemption, we all know that State
law governs private contracts made in that State. Federal
legislation providing fallback language for these tough legacy
contracts is essentially amending these contracts governed by
State law, retroactively inserting fallback provisions. So what
it sounds like is we are needing to preempt State law to a
degree, correct?
Either Mr. Coates, or if Mr. Van Der Weide is back on?
Mr. Walsh. Here at the OCC, we think it is very important
that there be consistency across all of the markets, and that
Federal legislation can help propel that consistency.
Mr. Huizenga. Yes. One of the concerns, in my closing
seconds here, is in an effort to avoid litigation, I am afraid
that we may be susceptible to litigation challenging the
constitutionality of interfering with these private contracts
under the Takings Clause of the 5th Amendment. So does anybody
else have any concerns about that? Either of the Mr. Coates or
yourself, Mr. Walsh?
Mr. Dan Coates. I would defer to those trained in the law
to answer that question.
Mr. Huizenga. Mr. Coates or Mr. Walsh, in the closing
seconds?
Mr. John Coates. What I would say is I think we can work at
a technical level to try to minimize that risk, and I think you
are right that there is risk of litigation no matter what, and
the question is how best to minimize it to the greatest extent
we can.
Mr. Huizenga. Thank you, and I appreciate the extra time,
Mr. Chairman. While I think both you and I are leaving to go
vote, I am assuming that we have coverage from some capable
colleagues of ours, correct?
Chairman Sherman. Mr. Casten has proven that he can get
back just in time. I am turning over the gavel to him.
And as to the constitutional matter, I will point out that
the contracts clause of the U.S. Constitution limits the power
of State Governments, not the power of the Federal Government.
Although the sanctity of contracts is an important principle,
it is not as constitutional a principle when Federal Government
takes action.
With that, I yield to Mr. Casten both for his questions and
for his service as Acting Chair.
Mr. Casten. [presiding]. Thank you very much, Mr. Sherman.
I am not sure how I got bumped up in the queue, but I guess
with great power comes great responsibility, or something like
that.
Chairman Sherman. I believe it is because others are not
there. If there is a more senior member of the subcommittee--
Mr. Casten. Perfect, perfect. I will take it, and I will
watch for staff letting me know who is next in the queue.
Thank you to all our witnesses, and I want to echo what
Chairman Sherman said at the start. This is one of these issues
that is, thankfully, so bloody complicated that it is
nonpartisan. So I hope you will forgive my lack of education on
this issue, but I would just like to understand.
I think I understand what we are doing, or at least what
the fulcrum of issues are on the day after LIBOR ends. What I
am curious for your view on is to what degree do we need to be
concerned about the days before it ends? Specifically, there is
a robust swaps and futures market and all of those folks who
are hedging out their LIBOR risk. We know that LIBOR has been
gameable. Presumably, the liquidity in those swaps and futures
markets is going to start shrinking as we get close to D-Day.
Is there sufficient vigilance from a regulatory perspective
for that period? Is there anything we should be watching for?
And if the answer is, ``That is a dumb question, Casten,'' that
is an acceptable answer as well. I am asking out of curiosity.
And I am happy for any of you who have thoughts on that, to
direct it to any particular witness.
Mr. Walsh. Here at the OCC, we have had a very well-
thought-out and aggressive program in our supervision
activities with respect to LIBOR cessation and transition since
2018. It was a phased approach in the first period. We focused
on awareness, communicating that LIBOR was ending and that
banks that we supervise needed to do an inventory and
understand their risk exposures. In the next phase, we added
preparedness, where we worked closely with the banks. I
mentioned in my opening statement the LIBOR self-assessment
tool that we first published as guidance to the banks we
supervise, and more recently have made public for the entire
financial institution community to use. It is a checklist, a
series of over 30 questions to identify risks that they might
have. And finally now, we are moving into a phase where we will
be very actively examining banks to determine the level of
preparedness that they have.
So we think that we are very well along in terms of the
before-the-end-date tasks that have to be undertaken.
Mr. Casten. Okay. But you are satisfied that those
forwards, futures, and swaps, those markets will stay robust as
long as we need them to stay robust and sufficiently liquid?
Mr. Walsh. Yes, I am.
Mr. Casten. Okay. So the second question is, I was in the
utility industry before I got here, and you have a lot of
contracts, like a lot of industries, where you have cost pass-
throughs for your customers, and in the context of a borrower
and a lender, I think I understand where the fulcrum of the
issues is here. But presumably, there is some quantum of
borrowers who have downstream contracts where they can pass
this risk along as it moves.
I am just curious whether there is any lingering--if we do
not mandate that everybody switches to a fixed product, to the
extent that some borrowers have the ability to pass whatever
the resulting risk is on to their customers, do we need to be
vigilant about that? Is there even any way to quantify how big
that risk is? Because you would have to start looking into a
lot of downstream contracts beyond the pure banking contracts.
But I presume there is a decent number of those pass-through
contracts out there.
Has anybody looked into that or understood it, or am I
barking up a short tree? Anybody can answer that question.
Mr. John Coates. In the absence of someone else answering,
let me just offer that actually litigation is hard to pass
through. There are ways you can do it, but if you are the
direct party, even if you have a perfectly matching ability to
recover on the economics, if you end up in litigation because
the terms of that security are uncertain, you are going to be
in litigation. So there is actually a kind of--regardless of
the economics of the position of that contract in the overall
market, you do have an incentive to look for clarity in what
has to be paid.
Mr. Casten. And I guess I am not thinking that you would
ever have a right to pass through litigation, but if I am not
mandated to go to another basis, and I do not have any
particular economic incentive to pick one basis versus the
other, is there any risk there that you might just default to?
I don't know. I am just curious if it is something we should be
thinking about.
Mr. John Coates. In effect, the terms of renegotiation
might not be well considered if the party doing the
negotiations--yes, I think that is a fair point for anybody
supervising.
Mr. Casten. Apologies for my ignorance, but I do appreciate
your time and your willingness to tolerate me.
The Chair will now recognize Representative Wagner from
Missouri.
Mrs. Wagner. Thank you, Mr. Chairman.
Mr. Smith, will you describe the steps that the Treasury
Department has taken and is taking to facilitate the transition
from LIBOR?
Mr. Smith. Yes. Thank you for that question and your
interest in this important issue. The Treasury Department has
taken several steps regarding the transition away from LIBOR,
all with the goal of trying to ensure a smooth transition that
avoids disruptions of financial markets, as well as for
businesses, consumers, and families who have financial products
related to these rates.
The Financial Stability Oversight Council (FSOC) that the
Treasury Secretary chairs has highlighted the risks surrounding
LIBOR and the transition for several years now, and encouraged
market participants to evaluate their exposures, and regulators
to collaborate on encouraging transition.
Treasury is an ex-officio member of the Alternative
Reference Rate Committee and has supported its work to
establish robust fallback language in contracts, to consider
alternative reference rates like SOFR, and to engage with
market participants about their use, encourage them to stop
using LIBOR where feasible, and begin using alternative rates,
if possible.
And lastly, the Treasury Department has published tax
rules, a proposal, with reliance to help manage the tax
consequences of the transition away from LIBOR so that
potential tax consequences don't become an impediment to
participants who want to transition away.
Mrs. Wagner. Thank you very much.
Mr. John Coates, will you describe the SEC's role in this
process and the steps the Commission and its staff are taking
to facilitate the transition, please?
Mr. John Coates. Thank you very much for the interest in
what we have been doing. Also, my written statement outlines
this a little bit more than I will do right now. But at a high
level, what we have been doing is to actively monitor the
extent to which public companies and other supervised entities
of ours are identifying, disclosing, and managing the risks
associated with the transition, particularly risks associated
with new contracts or tough legacy contracts that extend beyond
2021.
We put out some written guidance on how to approach these
topics, as well as risk alerts to investors to draw attention
to the issues that regulated entities and public companies
should all be considering as they engage in the transition.
Mrs. Wagner. Thank you very much.
Mr. Van Der Weide, will you describe the differences
between LIBOR and SOFR?
I don't think we can hear you.
Anybody else want to take a stab? I'm sorry, Mark. I don't
think we can--is it just me?
Mr. Smith. I can't hear him either, and I will be happy to
take that, if you would like.
Mrs. Wagner. Please.
Mr. Smith. LIBOR is a survey-based rate. It is constructed
by polling a panel of banks and asking them where they can
borrow. SOFR is based on transactions in the Treasury repo
markets, the overnight markets, and it is based on actual
transactions, not a survey of where people think they can
borrow. And it is based on collateralized borrowing, that is,
people pledging Treasury securities as the collateral.
So key differences are the transaction basis. SOFR has
almost a trillion dollars of the transactions that occur every
day, and they are actual, observable transactions that you can
see. They are actually done. LIBOR is a survey where banks
determine their submission sometimes based on transactions, but
often based on judgment, because they have no transactions to
reference.
I am sorry, ma'am, I can't hear you.
Mrs. Wagner. I'm sorry. I am trying to cut down on the
background noise.
Given the issues that we had with LIBOR in the past, could
you discuss a little bit, Mr. Smith, how SOFR addresses that
risk of manipulation, please? In my limited time.
Mr. Smith. Yes. The main way is because it is based on that
robust set of transactions that are so large and deep and done
by such a diverse set of market participants. That makes it
very hard to manipulate. The profit was also very transparent
for taking those transactions, how they are aggregated and
calculated in a final number, done by the Federal Reserve Bank
of New York, and done in compliance with International
Organization of Securities Commissions (IOSCO) principles.
Mrs. Wagner. Thank you all very much. I appreciate the
panel. I appreciate the discussion. And I will yield back.
Mr. Casten. And if I am following the grid properly, I
believe that in terms of participation, Mr. Foster from
Illinois is now up next.
Mr. Foster, you are recognized for 5 minutes.
Mr. Foster. First, I wanted to thank everyone who has been
working on this for a decade. I remember during the financial
crisis, you would wake up every day and check out the LIBOR
spread to find out if the world was ending or not, and then to
find out more than a year later that the whole thing was just
sort of made up made me a little bit queasy. So, it is nice to
see that we are finally fixing this.
I would like to ask some questions about whether people
expect systematic differences in the average rate of the
alternative rates. Will LIBOR be higher or lower on average?
Who are the winners and losers if it turns out that there are a
couple of basis points difference in these?
Mr. Van Der Weide. Can you hear me now? Can you hear me
now?
Mr. Foster. Yes, we can.
Mr. Van Der Weide. Okay. Sorry for all of the technical
difficulties.
There may be some differences in the rate. There are
different alternative rates that folks use as LIBOR is going
away. SOFR, the alternative rate that has been recommended by
the ARRC, is different in nature, as Brian Smith indicated,
than LIBOR. So, for example, daily averages of SOFR will show
more volatility than LIBOR, and SOFR will behave a little bit
differently in times of economic stress and financial crises
than LIBOR will.
But in general, the way that SOFR is implemented into
contracts is it is done through an average, and the average of
SOFR and LIBOR correlate quite closely together if you look
over the last 30 years of data. They correlate quite closely
together. So we think in the long haul, there shouldn't be
significant categories of winners and losers as people move
over to SOFR for derivatives and some other transaction types.
Mr. Foster. Are they based on averages or mediums or--
Mr. Van Der Weide. The version of SOFR that is used in
financial contracts is based on an average over multiple days,
and that averaging mechanism softens some of the volatility and
gets us to, I think, a more tractable result.
Mr. Foster. Okay. And are there already players in the
market betting that we are going to fix this one way or another
and trying to play the decision that is made in the legislation
here in the shift in the value of some of the positions that
are held on this? Is that something that is happening yet? Or
are people just counting on it being continuous and smooth,
with no disruption?
Mr. Van Der Weide. There are certainly investors out there
who are taking positions on the speed and nature of the way we
transition away from LIBOR. We are trying to ignore that noise
and move forward with the LIBOR transition in the way that we
think is most publicly useful. But there are certainly various
parties out there entering into different kinds of contracts
based on the nature and the speed of the LIBOR transition
process.
Mr. Foster. And what is the structure of such a bet that
one might be able to place?
Mr. Van Der Weide. I don't think I have enough expertise to
answer that one.
Mr. Foster. Is there someone else who might have a guess at
that?
Mr. Smith. I guess I would offer that the ARRC, in its
approach to thinking about fallback, tried to develop a process
that was transparent and fair for all participants, to avoid
that kind of winners and losers type of situation by developing
in advance a clearly laid-out approach for what the spread
adjustment would be when contracts fell back, having external
parties calculate a clear formula for it, and having that
trigger at the moment that the administrator of LIBOR announced
that it would be. So, those fallback amounts have already been
fixed earlier this year when the announcement was made.
Mr. Foster. And are there specific institutions that might
introduce systemic risk that have a special role in creating
any of these rates?
Mr. Van Der Weide. The nice thing about SOFR, one of the
main nice things about SOFR is that it does, as Brian indicated
earlier--there are a ton of underlying transactions, and they
come from a pretty diverse and large set of financial
institutions. So at least the primary alternative to LIBOR,
SOFR, is going to be one that is based on a large volume and a
diverse set of market participants.
Mr. Foster. Okay. And who is it that accumulates the data
for it? I just looked up something on the Web here at the
Federal Reserve Bank of New York, and it indicates that Mellon
had a special role in calculating the rate. I was just
wondering if we are very dependent on specific institutions
here, and if there may be systemic risk there?
Mr. Van Der Weide. I don't think in a problematic way, no.
Mr. Foster. Okay. Thank you.
I yield back.
Mr. Casten. The gentleman from Ohio, Mr. Stivers, is now
recognized for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman.
My first question is for Mr. John Coates. The SEC has an
important role to play in ensuring that Federal and State LIBOR
transition legislation is effective. As you know, the Trust
Indenture Act may require unanimous consent of note holders to
effect a change in the benchmark interest rate on those
transactions. Unanimous consent in practice is impossible to
achieve, especially on the scale of tens of thousands of note
holders, and the requirement in this unique scenario could harm
investors that the Trust Indenture Act (TIA) is meant to
protect. Therefore, narrow, targeted guidance and relief
related to the application of TIA might be necessary to reach
the end goal of amending contracts in an expedient manner,
while at the same time staving off uncertainty and potential
litigation.
Mr. Coates, do you think that the SEC will be able and
willing to issue some narrow and targeted guidance related to
the Trust Indenture Act and the LIBOR transition?
Mr. John Coates. Thank you for that question. I think it is
a very good question, and it highlights an important difference
in the way that State and Federal law can respond or anticipate
the transition here. It is exactly correct, as you summarized,
that the Trust Indenture Act can create problems. The SEC does
have an ability to provide exemptive relief under that Act. I
would note that it would require a Notice and Comment
Rulemaking, as we understand the role that we would be likely
to play, which, as you know, can take some time. And I will
also note that the bill that I think is being discussed here
would directly address the question, as well.
So I think we are ready to both help in the technical sense
with language in this bill, as well as consider the potential
need for exemptive relief if that becomes necessary.
Mr. Stivers. Great. Thank you. That is really the only key
question I had, and I appreciate everybody's hard work. I
appreciate all of the witnesses. This is a very important
transition for our financial markets. It is important that we
get it right.
This is not, as the ranking member said in his opening
statement, a partisan issue at all. Republicans and Democrats
both want to get this transition right, and we stand ready to
work with the Administration and the SEC and the FHFA and the
Federal Reserve in any way we can. I look forward to starting
to move this legislation forward. I know that the Chair of the
subcommittee has been working on this a while and cares a lot
about it.
With that, I yield back.
Mr. Casten. It is nice to see the generosity of spirit
across the aisle, and with the clock, which is freeing up so
much extra time here.
The gentleman from California, Mr. Vargas, is now
recognized for 5 minutes.
Mr. Vargas. Mr. Chairman, thank you very much. I appreciate
the opportunity to speak.
And I also want to thank each and every one of our
witnesses today.
I don't know if anyone remembers Y2K, but I was on the San
Diego City Council, on the Public Safety Committee, and I
remember that New Year's Eve. I had never been so nervous,
because we didn't know what was going to happen. I remember
sitting there in the police department, thinking all of the
lights were going to go off, because we were told all these
crazy things were going to happen. The street lights were going
to go down, all of our signaling for the traffic was going to
go down potentially, police weren't going to be able to
communicate with each other. So I remember sitting there with
the chief of police, the chief of the fire department, the
mayor, and all of us were, like, we don't know, let's see what
happens.
Nothing happened, thank God, and we kept going. And the
reason for that was we were prepared. We had worked hard on
this and people were prepared.
That is the way I see this, to be frank. It sounds like you
all have been working hard; 99 percent of potential problems
seem to have been anticipated and corrected. This 1 percent is
$2 trillion, and that is nothing to sneeze at. But it sounds
like most of the issues have been solved.
So my question here is, on this last little bit, how really
could consumers be hurt? What would be the big difference to a
consumer if we didn't fix this legislatively? I hope that we
will, and it sounds like we will. But if we didn't, what would
be the damage? Can somebody explain that to me?
Mr. Dan Coates. Congressman, our concern with the need for
a Federal legislative effort is that, as you know, a lot of
these mortgages and mortgage contracts are written differently
in different States. The advantage of a Federal effort is that
all consumers would be assured of a predictable, fair, and
equitable solution regardless of in what State they live. So
our efforts have been designed to try to minimize disruption,
and that is why we think there is great value in the Federal
legislative effort.
Mr. Vargas. I think there is, too, obviously, but what
happens if we don't have, for some reason--I don't know if you
guys know why we are walking across the street so crazily today
is because someone decided that we should vote on everything.
This is not our normal procedure. Normally, we would sit here
and talk to each other and we wouldn't be disrupted. I am
sitting here looking at the clock, knowing I have to run off.
This is not normal, and sometimes things happen here that are
abnormal. It is abnormal what is happening today, and I
apologize for that, for your time. It is inappropriate, and I
apologize.
But what would happen if somehow this thing were to fall
apart?
Mr. Dan Coates. Our concern is that there are some who may
not move, or who may be worried about expressing their
discretionary ability because they don't know how it will be
interpreted in various States. The advantage of the Federal
legislation is that not only do consumers understand a fair and
equitable solution will come across the board but also the
administrative ability to move these contracts will be able to
move them with some degree of--
Mr. Vargas. I understand the benefits of it, but I am
asking the opposite; what are the risks? Can anyone else answer
that? What are the risks? What if the thing falls apart? What
if we do have suspension built in and some crazy person decides
that we have to vote on each and every one of them, as opposed
to just taking them en bloc, as we normally do? What happens if
someone gets a wild idea here and we are not able to fix this?
What happens? Can someone talk about that? What is the
downside?
Is anyone going to take a shot? If not, I will pick on
somebody here.
Go ahead, Mr. Smith. I will pick on you.
Mr. Smith. Sure, I am happy to take that. As you say, it is
really important that consumers don't have their normal life,
their normal economic activity disrupted by something that is
far away and something that no one is really paying attention
to. So, we wanted to pay very close attention to that issue.
If this LIBOR transition does not go well, people may not
know what their mortgage payment is if it is linked to LIBOR.
They may have their credit card payment disrupted. Financial
markets may be disrupted. Lending to businesses may be
disrupted. Litigation will take over, and I think it will be
disruptive to markets and disruptive to consumers.
Mr. Vargas. Thank you for your work. I really do appreciate
what you guys are doing, I really do. Thank you.
Chairman Sherman. I believe that every member in attendance
has asked their questions. Am I correct on that?
Mr. Huizenga. Mr. Chairman, Bill Huizenga here. I talked to
a number of our members on the Floor that I know were in the
queue. I know some of them were trying to vote at the end of
the last bill and the beginning of this one, so I am not sure
who the last Republican was. I just walked in. Do you mind
informing me who that was?
Chairman Sherman. Who was the last Republican to speak?
Mr. Stivers has asked questions.
Mr. Huizenga. Okay. I do know that Mr. Steil, Mr. Gonzalez,
Mr. Hill, and I think Mr. Davidson, were all in our queue. I
don't know whether or not they have returned.
Chairman Sherman. I see we do have a member to recognize.
Mr. Hill is recognized for 5 minutes.
Mr. Hill. Thanks, Mr. Chairman. I appreciate this good
hearing on a super-important topic. Thanks for your high-
quality opening of the hearing, and thanks for helping us
navigate these votes this afternoon.
Mr. Van Der Weide, I want to start out with just sort of
the big picture. The staff information I have seen is there is
about $16 trillion of notional value that will be outstanding
in legacy contracts after June 2023. Is that the right number
for us to be thinking about of the legacy transactions?
Mr. Van Der Weide. I would say that our expectation for
total legacy contracts by mid-2023 is more in the range of $70
trillion, but only about $10 trillion of those would be what we
would consider tough legacy contracts that have inappropriate
fallback provisions that are very difficult for the contracting
parties to renegotiate. So $10 trillion, I think, is the number
that we are focused on.
Mr. Hill. Good. That is very helpful. Thanks for that
clarification, because that was one of the items that I wanted
to clear up.
Mr. Coates, I have long advocated for this change. The
whole 6 years I have served in Congress, we have been talking
about it, and we are superb here in D.C. in talking about
problems, and you are aware of that. In fact, last January,
when FHFA testified, I asked then, what is the status of Fannie
Mae and Freddie Mac being ready to go in their conversion. Can
you give us an update, please?
Mr. Dan Coates. Sure. And thank you for the attention to
FHFA's work. I appreciate that.
Our regulated entities have really done a lot of work to be
ready for this transition. They started by writing new contract
language within the confines of the ARRC to ensure that those
LIBOR contracts that were written had clearer fallback
language.
We then got consumer groups and all interested parties
together with the ARRC to set up new LIBOR ARMs, and they
started building those. And after we got those built, we have
prohibited the Enterprises from issuing LIBOR-based products
anymore, or purchasing LIBOR-based products.
They are largely transitioned away from LIBOR, to SOFR, in
all of their mortgage-based products, so we feel pretty
comfortable. The one remaining area is some derivatives
activity, and we expect the LIBOR-related derivative activities
to drop off as SOFR derivative liquidity increases.
Mr. Hill. Good. Thanks for that answer.
So, Mr. Walsh, I was curious, in the Majority staff's memo
to the committee, they talked about some ambiguity for small
and medium-sized banks and their discomfort with SOFR. Having
been a former CEO of a medium-sized community bank, I really
couldn't tell from their memo what is driving that. We didn't
use LIBOR in our portfolio lending. We used Wall Street Journal
prime, plus or minus, competing, obviously, with LIBOR quotes.
Tell me what is going on with the community banks where they
have discomfort with this?
Mr. Walsh. Thank you for that question. It is a very
important one.
As my colleague, Brian Smith, mentioned earlier, SOFR is an
overnight risk-free rate, and it has great benefit in that it
is transparent. The two issues that community banks, as well as
some corporate-type borrowers, have expressed with respect to
SOFR is that it doesn't include a credit component. It is an
overnight risk-free rate. And there is much work being done at
present to address that, to try to create a credit spread that
would be appropriate to apply to SOFR to make it more credit-
sensitive.
It is also, as I think Mr. Van Der Weide was describing, an
average rate. LIBOR is a rate that is set in advance and paid
in arrears, and there has been some concern expressed by
various parties that they will find it difficult to manage
their cash flow positions if they do not know at the start of a
reset period what the final amount of interest due might be.
There is work being done to address that in trying to find a
so-called forward-looking term rate for SOFR.
Mr. Hill. I hope you and your bank supervisors will
collectively help push that education and collaborate on a
solution there.
Mr. Van Der Weide, another question I was curious about. We
talked about State legislation. The State of New York is curing
part of this. How do you reference it? Has the General Assembly
of New York passed any legislation on this, and what percentage
of the market might that assist?
Mr. Van Der Weide. We think the New York legislation will
probably cover a majority of the financial contracts out there
under LIBOR, but for a variety of reasons we do think that
Federal legislation is really needed to provide that kind of
nationwide uniform solution and to cover some of the central
Trust Indenture Act and tax issues.
Mr. Hill. Good. Thank you.
Mr. Chairman, I appreciate the time, and I yield back.
Chairman Sherman. Thank you.
Without objection, I will enter into the record letters
from SIFMA, the Structured Finance Association, the American
Bankers Association, and the American Council of Life Insurers,
and others, in support of Federal legislation in this area, and
a letter from the Structured Finance Association making
basically the same point, and a statement from the Structured
Finance Association.
Withput objection, it is so ordered.
And I now recognize Mr. Davidson.
Mr. Davidson. Thank you. I was expecting the rotation to go
to a Democrat, but it is nice to be in the queue. Thank you,
Mr. Sherman. Thank you, Mr. Hill. And thanks to our witnesses.
This is an important topic for our financial markets, and
it is always good when Congress spends time on things that are
actually substantive.
A lot has already been said. I like that it has already
been highlighted that this is an average. So it is designed to
smooth out some of the day-to-day volatility, and it is
designed to mitigate some of the volatility because of that.
But I am particularly interested in going back to September
of 2019 and the repo market. We saw that spike. Should we be
worried about this happening again, Mr. Van Der Weide? If so,
what would be the implications we would have under a new SOFR-
based system?
Mr. Van Der Weide. We have seen some dysfunction in the
Treasury markets over the last couple of years. We saw it in
September 2019, and we saw it again in March of 2020. We and
our colleagues at Treasury and some of the other agencies are
taking a hard look at what we can do to improve the resiliency
of Treasury markets.
I will say that the SOFR spike, the Treasury repo spike in
September of 2019 was very short-lived, in part because of some
of the actions the Federal Reserve took in response to it. But
because of the way SOFR is integrated into financial contracts,
through a longer-term average, spikes in SOFR that only last
for a day or two, like what occurred in September of 2019, are
not going to have a bad volatility effect on the usage of that
rate in the contracts. I think through the averaging mechanism,
we have a good mechanism to deal with some of the short
volatility spikes that might occur in Treasury repo rates.
Mr. Davidson. Okay. So do you anticipate enough stability
in repo that the Fed will not actively intervene in repo, or
how do you see that playing out? And what role does SOFR play
in that?
Mr. Van Der Weide. We think the averaging mechanism is
going to be enough to deal with the volatility, the national
volatility in Treasury repo rates. But I should also mention
that SOFR is not a mandated rate. We are not mandating that
banks or financial firms use SOFR in their contracts. So if
they are concerned about the volatility of SOFR for certain
transaction types, they are certainly able to migrate to a
different alternate rate.
Mr. Davidson. In the crisis, of course, everyone hopes to,
first and foremost, create some stability. But there was
concern when this high amount of interest was being paid out in
the repo market, and it was being paid above what some of the
offers were from other banks. There were some banks who were
maybe as high as 10 percent.
Now, that didn't last in an enduring way, as you have
already highlighted, but I heard from banks who said that they
were offering to finance substantially lower, and the market
could have cleared, provided stability at a lower rate. Did you
deal with any of those claims?
Mr. Van Der Weide. I think fundamentally the disruptions in
the Treasury repo market back in September were quite short
term, so they are not going to impact the nature of the SOFR
rate that is going to be used in financial contracts. Those
kinds of very temporary disruptions are not, I think, a black
mark against the potential use of SOFR.
Mr. Davidson. Okay.
Mr. Coates, what has FHFA done to ensure that its regulated
entities are prepared to transition away from LIBOR, and what
kind of exposure is there left for LIBOR?
Mr. Dan Coates. Thank you for the question and for your
interest in FHFA's regulated entities.
As I outlined earlier, the Enterprises--Fannie and
Freddie--and the Federal Home Loan Banks have been moving
prudently away from LIBOR and to SOFR since we started this
effort in 2018. They have worked, in Fannie and Freddie's case,
with the Consumer Products Working Group to develop new
fallback language to ensure that those last few LIBOR contracts
had clear roadmaps for how they would transition.
Then, they worked with all of the industry groups and
consumer groups to develop an acceptable adjustable rate
mortgage based on SOFR, and then they went and built that
system. They have offered now SOFR-based adjustable rate
mortgages and other mortgage products, and they are out of
LIBOR mortgage-based products.
Mr. Davidson. Won't there be about two-thirds still
outstanding after 2023?
Mr. Van Der Weide. As you may know, the exposure
information is not public, but I would be glad to follow up
with you and discuss the exposure information, if you are
interested.
Mr. Davidson. Okay. Thank you so much.
My time has expired, and I yield back.
Chairman Sherman. Thank you.
Without objection, we will add to the record a letter from
the United States Chamber of Commerce and related organizations
supporting Federal legislation along the lines of the
discussion draft that has been circulated; a letter from the
Alternative Reference Rate Committee supporting the specific
draft that has been circulated; and a letter from Americans for
Financial Reform, the National Consumer Law Center, and the
Student Borrower Protection Center supporting the New York
legislation, which is substantively identical to the discussion
draft that has been circulated.
With that, I recognize Mr. Emmer for 5 minutes.
Mr. Emmer, are you there?
Mr. Emmer. I am. If I could yield my time to Mr. Gonzalez,
please?
Chairman Sherman. Mr. Gonzalez, you are now recognized.
Mr. Gonzalez of Ohio. Sure. You caught me off guard there,
Tom. But in any event, thank you for yielding.
Thank you, Chairman Sherman and Ranking Member Huizenga,
for holding this hearing today. It is certainly an important
topic.
I want to also commend the ARRC for the work they have done
over the years. I feel like if the ARRC didn't exist, we would
be probably talking about how to create it and make sure it
exists today. So, I certainly appreciate all of the work and
all of the thought that has gone into the various proposals.
I want to start with Mr. Smith. I was pleased to see that
the State of New York just enacted legislation that does
provide for a legal safe harbor to address financial contracts
that have inadequate fallback language, which we know sort of
comprises that tail risk. However, it doesn't fully address the
Federal issues.
From this past year's experience, we know that
securitization trustees, for example, were taking steps toward
initiation of litigation, which is more than a year prior to
the original LIBOR end date of December 2021. So with that as
the backdrop, how concerned are you that we would see
additional litigation soon, and maybe paint a timeline for us.
The longer it takes us to enact something at the Federal level,
when do you see the litigation coming, and in what kind of
volume?
Mr. Smith. Thank you for the question. As you highlighted,
New York has taken an important step for managing risk for
contracts based in New York law, but there remains a necessity
for Federal legislation both to make sure we have a
comprehensive and uniform approach that covers all of the
United States, as well as because of the unique Federal issues.
You identified the trust and bank issue. That is one of
several issues. We also want to make sure at the Treasury
Department that we can manage the tax consequences of LIBOR
transition and make sure that doesn't become an impediment.
There are certain legacy student loans based on the legacy
program that have a reference to LIBOR in statute. Those are
just some of the Federal issues that we want to make sure to
manage. And as you highlight, litigation is certainly a risk if
they are not managed appropriately.
Mr. Gonzalez of Ohio. Thanks. Do you suspect that Treasury
will provide legislative guidance or suggestions with respect
to handling the tax consequences and the issue in the student
loan market?
Mr. Smith. Yes. Treasury has provided technical assistance
on the draft legislation related to managing the tax
consequences, with an aim of ensuring that tax realization
events are not triggered by the move from LIBOR to SOFR,
including by this legislation, as well as by making sure that
Treasury has appropriate authority to do rulemaking to cover
the broad range of technical issues that might come up.
Mr. Gonzalez of Ohio. Great.
And for Mr. Dan Coates, without an appropriate authorized
alternative solution, many of the parties responsible for
directing LIBOR-based calculations have already notified the
contractual parties that they will seek court direction. Can
you explain the implication of massive litigation on financial
markets? And then, who ultimately would bear the cost of this
litigation?
Mr. Dan Coates. I appreciate your question. There are a lot
of entities that will bear the cost if folks don't move. As you
know, Fannie Mae securities are governed by D.C. law, and
Freddie Mac's by New York State law, and the Federal Home Loan
Banks all around the country. So the challenge if folks don't
move, and if the lawsuits happen all over the place--we already
saw this before the New York State law was started--trustees
were starting to go to the courts to seek resolution. So, the
real challenge is that this transition would be stalled in 51
jurisdictions, and that could end up getting different outcomes
in the different jurisdictions, which could affect consumers
differently. So, we are very concerned about that.
Mr. Gonzalez of Ohio. Thank you.
And then with my last few seconds, according to market
participants, whom I hope we hear from publicly at some point,
implementing the transition will require significant
operational and systems changes. So based on the current
timeline, are you concerned about interruptions to the
marketplace?
That one is for either Mr. Dan Coates or Mr. Smith.
Mr. Dan Coates. I will just take a shot at it. We have seen
good progress. The ARRC has had an Infrastructure Working Group
to bring vendors in to get them ready, and we have every
expectation that things will make more progress.
Mr. Gonzalez of Ohio. Thank you, and I will yield back to
Mr. Emmer, or just yield back altogether. I don't know if he is
on.
Chairman Sherman. I don't see him. I do want to comment
that the discussion draft that I have circulated does contain,
as Section 6, a provision that shifting from one index to the
other index does not constitute a sale exchange or disposition
of property for tax purposes. The other technical assistance
that Treasury has sent in was just received yesterday, and I
know it will be very interesting to myself, Mr. Huizenga, and
others working to perfect this draft.
With that, I will recognize Mr. Steil for 5 minutes.
Mr. Steil. Thank you very much, Mr. Chairman. It has been a
good hearing today and a good discussion of LIBOR. I want to
shift gears slightly just for one minute, if I could, while we
have you, Mr. Coates. I would like to ask you about some recent
statements from your office regarding SPACs.
Last week, you put out a statement kind of opining whether
Special Purpose Acquisition Companies (SPACs) were ideal. A
popular commentator called the remarks, ``a weird speech,'' his
words, that was really, ``advice for plaintiffs' lawyers,''
also his words, rather than anything related to SEC enforcement
priorities. And then this week, alongside the SEC's acting
Chief Accountant, you issued another statement that I think had
some market implications regarding how warrants are issued and
SPAC offerings and how they should be treated for accounting
purposes. One of the major law firms actually noted that it has
essentially frozen the SPAC marketplace as a result of some of
those comments. And the firm pointed out, in the public comment
that I read, that they were not aware of a statement put out
without notice or comment that had such a chilling effect on
capital market activities.
I read your statement and I noticed there was a pretty
solid, well-written disclaimer in the footnote of your
statement. But admittedly, despite that, I think many people
out there are worrying that these comments may have greater
teeth. Did you determine the significant market-moving
statements are appropriate?
Mr. John Coates. Thank you for those questions about SPACs.
I am happy to give you a quick answer now. I don't want to
distract from the LIBOR focus of the hearing, and I am happy to
go at much greater length, if you would like, after this with
my staff and your staff.
Very briefly, yes, we believe that the statements were
appropriate for protection of investors and issuers and capital
formation. I will note that the accounting statement that came
out this week is not reflecting anything new. The guidance
comes from FASB. That guidance has been there for years. And
the reason that we put it out is because a particular
registrant came to us with the questions and asked for our
advice, and we gave it. Once we gave it, we recognized it might
have implications for other issuers and did not feel
comfortable not telling the market about the conclusion that we
had reached about that question.
But again, as I said, I will be happy to follow up later,
if you would like, with more information.
Mr. Steil. Thank you for the background as to the
orientation of the formation of those comments. Should we
expect a more formal rulemaking on this issue in the near
future?
Mr. John Coates. I guess I would have to say I look forward
to working with our new Chair, who will come on board very
shortly, and talk about that issue with him and the rest of the
staff at the SEC.
Mr. Steil. Very good. I appreciate you letting me shift
gears there for a second.
Let's pivot back to LIBOR, which I have actually been
pretty interested in since I first arrived on this committee. I
spoke about this topic in 2019, and while it seldom makes the
front page of some of the newspapers, I think the LIBOR
transition is actually one of the more important stories
affecting our economy. So if I could ask a question for you,
Mr. Van Der Weide.
In a speech delivered to the Alternative Reference Rate
Committee last month, Vice Chairman Quarles sought to address
rumors that the transition from LIBOR will be delayed further.
Do you think the message has been fully received that LIBOR is
really ending? This is one of my concerns.
And then, in particular, how do New York's recent moves
impact the pace of this transition?
Mr. Van Der Weide. I think the statements that we heard
last month from the U.K.'s Financial Conduct Authority and the
administrator of LIBOR were pretty definitive that major U.S.
LIBOR tenors are ending in June 2023. I think that message is
getting across. We are certainly getting that message across
during our supervisory process. We have issued, along with our
sister banking agencies, the OCC and the FDIC, several pieces
of supervisory guidance over the last few months, and that is
reinforcing the significance of the imminent demise of LIBOR
and the cessation of writing new contracts under LIBOR. So, I
consider the end of LIBOR to be set at this point in the middle
of 2023.
Mr. Steil. I appreciate that.
In observance of the time remaining, I appreciate
everyone's time today discussing this important topic, and with
that, I will yield back.
Chairman Sherman. Thank you. I assure you, Mr. Steil, that
we will focus on SPACs at the subcommittee level expeditiously.
And without objection, I will put in the record a letter
from the National Association of Federally-Insured Credit
Unions supporting the idea of Congress taking legislation
promptly on the LIBOR contracts consistent with the discussion
draft that has been circulated.
Without objection, it is so ordered.
And I believe the next person in line is Mr. Hollingsworth,
so I will recognize him for 5 minutes.
Mr. Hollingsworth. I appreciate that, Mr. Chairman. And I
certainly appreciate all of the witnesses that we have here
today.
As my good friend, Mr. Steil, said, this is an important
issue. The numbers that we are dealing with--and certainly the
chairman introduced this concept--are enormous, and making sure
that we have an elegant solution to this transition is really
important to both the real economy and the financial economy.
Nothing I am going to ask about should minimize my sympathy for
the problem that we have before us in transitioning a whole
host of contracts that don't have an appropriate fallback or
any fallback at all.
All that being said, and with the additional preamble of me
not being a lawyer but always being concerned about the rights
of parties to contracts, I wanted to ask Mr. Van Der Weide, do
you have any trepidation or concern about the notion that the
Fed is going to pick a rate, and that rate is going to be
conclusive and binding upon parties that have agreed to a
contract, and they, at least as I read the legislation, will
not be afforded any sort of litigation avenue, cause of action,
or other redress should they disagree with that? Is that
concerning to you? I understand the problem that we have ahead
of us, but are we going too far in saying presumptively that if
you don't contest it, this is the rate, but instead saying,
this is the rate, period, your only option is to contest this
law altogether, not contest with the counterparty whether that
is the right rate?
Mr. Van Der Weide. I do agree with the impulse here that it
should be a rare situation when Congress or legislators are
overriding private contracts, and you only want to do that in a
very narrow way for a very important government purpose. I
think we have a very important government purpose here, to
prevent financial stability negative effects and the litigation
that may come by mid-June. We want to do this in the most
narrowly tailored way possible, because I do think the Federal
legislation needs to be strictly limited to legacy contracts.
It should not be relevant looking forward to new contracts. It
should only apply to legacy contracts that have no fallback
rate or an inappropriate fallback rate, and people should have
the ability to opt out of a rate that is set by the
legislation.
So, should contracting parties take a look at where the
government-recommended rate is if they don't like it and they
want to go a different route? They should be able to amend
their contract and opt out. I think that is the way to maximize
the benefits here.
Mr. Hollingsworth. I really appreciate that very thorough
answer. I certainly concur that this is a big problem ahead of
us. I certainly concur with your hesitation or desire to
narrowly do this. And this is the first time I have actually
heard someone say there should be an opt out or a means of
redress should they disagree with that. That is something, a
bar that I also agree with.
I have a little bit of concern--I like the idea of
minimizing the logistical hurdles by saying this is the rate
unless you contest it otherwise, and maybe even setting
timeframes around that, that this is going to be your reference
rate going forward. But I want people to have the ability to
contest that, because they are ultimately the parties to that
contract, and if they believe that is inappropriate, they
should have their day in court to go argue before a judge and
have that judge determine whether it is appropriate or
inappropriate, what has been done.
Is that kind of what you are saying, as well? Not to
characterize what you are trying to say.
Mr. Van Der Weide. I think the fundamental issue here is,
do you want to have a legislature step in and provide clarity
to the financial markets about what some of these replacement
rates are going to be for that tranche of contracts that are
legacy?
Mr. Hollingsworth. Yes. But as you said, we don't want that
clarity to come at too high a cost. If we, by principle of
government, believe you should have access to the Judicial
Branch to argue in front of a judge and have a judge decide
what is appropriate or inappropriate, I believe that if you
abandon your principles at a time when a big problem is afoot,
then you probably didn't have those principles to start with.
Mr. Van Der Weide. I think the balance you have to strike
is between the clarity that we really need when LIBOR goes away
in 2023 and the judicial right of review. I think the more
judicial right of review you are going to have, the more
litigation we are going to have, the more uncertainty we are
going to have in the financial markets. So, we have to strike
the right balance between those two.
Mr. Hollingsworth. I think you are exactly right.
``Balance'' is the operative term, and certainly I would love
to work with Chairman Sherman in further fine-tuning. I think
he is on the right track, but we should strike that balance to
make sure there is a means for a party who has agreed to a
contract to take it before a judge. That is really important to
me.
Thank you. I yield back my time.
Chairman Sherman. Thank you.
One clarification for the record. I think the record was
already clear. The Americans for Financial Reform, the National
Consumer Law Center, and the Student Borrower Protection Center
have not endorsed Federal legislation. They have not endorsed
the drafts that I have circulated. They have endorsed the New
York bill, which is substantively identical to the Federal
legislation that we are discussing here today. That is as far
as they have gone. I think I have correctly characterized them
twice in this hearing already, but that will be a
clarification.
At this point, I believe we have heard from all members who
have asked their questions. What I am going to suggest is that
Mr. Huizenga grace us with a 1-minute closing statement. I will
then deliver a 1-minute closing statement, and at that point
our members and witnesses can zoom off to their next meeting.
Mr. Huizenga?
Mr. Huizenga. Thank you, Mr. Chairman. We will zoom off to
our votes, as well.
I do appreciate your having this hearing. I know this is
something that has been important. What I am hoping for in the
next hearing is that we are going to be able to hear from
market participants, those who are going to be affected by this
material change in those contracts.
As I had started to explore a little earlier, it sounds
like we may have some legal experts in here as well to just
comment on the constitutionality of this. I know you believe
that you have addressed this, or you certainly attempted to
address this, but looking at what the legality of this effort
is is an important part of this process in my mind.
As has been noted, June of 2023 is that sort of drop-dead
time. In classic Washington experience, that would mean May of
2023 is when we would get to it. But we are well ahead of that
time, and I commend you for that, and I am glad to be a part of
it and look forward to working with you on this.
Chairman Sherman. I look forward to working with you. The
importance of this issue is at least $2 trillion in instruments
that will still be outstanding after the middle of next year
that do not have a fallback position. But if I heard Mr. Van
Der Weide's testimony correctly, his number is closer to $10
trillion. I realize we are dealing with $200 trillion in
evaluating what is so many different instruments, and applying
it is difficult. So, we may be dealing with a problem that
involves $10 trillion in instruments.
As to the sanctity of contracts, I think that we can deal
with the Office of the Legislative Counsel and maybe the
experts at the Congressional Research Service (CRS). I don't
anticipate having another hearing where we bring in legal
experts, but if we don't get a clear answer from them, then we
do have to make sure that our bill will be constitutional.
I will point out that the principle of the sanctity of
contracts is a principle important to all of us in every
circumstance, but as a constitutional matter is applicable to
State legislation.
I will also point out that New York State has passed
legislation that would govern many of these instruments unless
we pass our bill. Adding to the confusion is that the
constitutionality of their bill is much less certain.
And finally, let's point out, as far as sanctity of
contracts, the 95-percent-plus of drafted contracts that are
clear as to how they would apply in a LIBOR-less world, the
sanctity of those contracts is being respected. Where the
parties didn't agree, it is much more efficient to have a bill
than to have hundreds and hundreds of lawsuits. Although as an
old-time lawyer, the idea of my colleagues billing thousands
and thousands and thousands of hours is something that they
would want me to support.
With that, we stand adjourned.
[Whereupon, at 3:51 p.m., the hearing was adjourned.]
A P P E N D I X
April 15, 2021
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