Federal Reserve "number three figure," and New York Fed President John Williams announced on Thursday that the New York Fed will establish an institution composed of private market participants to oversee the use of benchmark interest rates or reference rates in the entire financial market. This institution will be named the Reference Rate Utilization Committee (RRUC), and the inaugural meeting will be held on October 9th.

Williams announced this decision at the opening ceremony of the 10th Annual U.S. Treasury Market Conference held by the New York Fed that day.

Williams stated, 'The Reference Rate Usage Committee will begin holding meetings in October, focusing on key issues related to reference rates, including how the use of reference rates has evolved and what changes in the market might support reference rates.'

The Federal Reserve's 'third figure' also added that the group convened by the New York Fed will 'promote' 'best practices' related to the use of reference rates, including suggestions put forth by the Alternative Reference Rates Committee (ARRC) supported by the Federal Reserve.

The reference rate is used as a benchmark for setting other rates. With the most significant market reference rate of the past half-century—LIBOR—exiting the stage of history, in the United States, the Alternative Reference Rates Committee has in recent years identified secured overnight financing rate (SOFR) as the alternative choice. This rate is sourced from overnight repurchase agreements backed by U.S. Treasury securities.

The LIBOR manipulation case during the 2008 financial crisis and the scandal in 2012 where major banks colluded to modify LIBOR for profit exposed the 'trust crisis' faced by LIBOR, gradually losing market liquidity support. Since 2012, with the profound impact of international LIBOR manipulation scandals on financial institutions, prompting regulatory authorities worldwide to collectively promote interest rate reforms.

Williams stated that, 'The LIBOR incident has taught us two important lessons - first, significant systemic risks gradually form in the global financial system over time; and second, solving this problem requires complex, expensive, and up to ten years of effort. We must not repeat the same mistakes.'

It is worth mentioning that the New York Fed recently suggested modifying the calculation method of SOFR in July. Many Wall Street strategists also believe that, given the evolution of the repo market since the introduction of this benchmark in 2018, potential modifications are necessary.

Currently, SOFR still has two relatively obvious flaws: first, it lacks a forward-looking interest rate curve, and second, it lacks a credit component, both key features of Libor that SOFR lacks.

In fact, we introduced this aspect over a year ago when LIBOR officially exited the stage of history:

The SOFR term structure is not as complete as LIBOR - LIBOR has 7 tenors, while SOFR is based on the overnight repo rate in the U.S. Treasury repo market. Even the futures trading by CME based on the overnight SOFR currently only includes four tenors: 1 month, 3 months, 6 months, and 12 months.

Furthermore, SOFR is a Treasury repo transaction rate, excluding credit risk, it may not accurately reflect the true financing cost of financial institutions. Using SOFR as a benchmark rate could also increase the difficulty of international comparisons.

Williams stated, "The ARRC's work will complement the efforts of international institutions such as the BIS and the FSB in the use of benchmark rates, ensuring that we will not face problems similar to Libor again."

According to the announcement, Morgan Stanley's Deputy Chief Risk Officer Patrick Howard will serve as the inaugural chair of the ARRC. In a press release, he stated, 'The financial industry and the public sector must work closely together to support the sustainable use of benchmark rates.'

Editor/Rocky