One Proposed LIBOR Replacement Has ‘No Clothes,’ Says SEC Chairman

WASHINGTON–Gary Gensler, chairman of the Securities & Exchange Commission (SEC), believes one of the benchmarks being proposed as a replacement for LIBOR has “no clothes.”

Gary Gensler

In remarks before the Alternative Reference Rates Committee’s SOFR Symposium, Gensler said he was sharing his own views and not those of the SEC, and his view does not align with many of those backing a move to the Bloomberg Short-Term Bank Yield Index from the London Interbank Offered Rate (LIBOR).

“As some of you may know, when the topic of LIBOR comes up, I sometimes find myself thinking about Hans Christian Andersen and Warren Buffett. Others of you might be wondering why I’d mention these two men — born 125 years and an ocean apart — in the context of LIBOR,” Gensler told the meeting. “Well, as Hans Christian Andersen wrote in his famous folktale, ‘The Emperor’s New Clothes,’ the emperor has no clothes.”

And who is the emperor? It’s many of the replacement rates being suggested to fill LIBOR’s long-time place, said Gensler, adding he believes a good number of those replacements indices share many of the same failings as LIBOR.

Appropriate Clothing

“Today, as we transition away from LIBOR, I want to be sure our replacement rates are appropriately clothed,” Gensler said. “To that end, I have several concerns about one rate that a number of commercial banks are advocating as a replacement for LIBOR. This rate is called the Bloomberg Short-Term Bank Yield Index (BSBY). I believe BSBY has many of the same flaws as LIBOR. Both benchmarks are based upon unsecured, term, bank-to-bank lending. BSBY has the same inverted-pyramid problem as LIBOR. Like with LIBOR, we’re seeing a modest market, shouldering the weight of hundreds of trillions of dollars in transactions. When a benchmark is mismatched like that, there’s a heck of an economic incentive to manipulate it.”

According to Gensler, the markets underpinning BSBY not only are thin in good times; they virtually disappear in a crisis. “Last spring, the primary commercial paper lending market evaporated for about five weeks during the initial stresses of the pandemic,” he noted.

Preferable Alternative

“That’s why I agree with the ARRC that the Secured Overnight Financing Rate (SOFR), which is based on a nearly trillion-dollar market, is a preferable alternative rate,” said Gensler. “Earlier, I said that the emperor is LIBOR. I’d hate if we replaced one clothes-less emperor with another based on the unsecured, term, bank-to-bank lending market that has dried up. This brings me to Warren Buffett. He’s said, “You only find out who is swimming naked when the tide goes out. I worry that a crisis will reveal BSBY’s flaws all too clearly. Let’s not wait for the tide to ebb to see the emperor still has no clothes