LIBOR Replacement Begins Publication

On April 3, the New York Federal Reserve Bank began publishing the Secured Overnight Financing Rate (SOFR), a daily, broad Treasury repo financing rate that the bank’s Alternative Reference Rate Committee (ARRC) recommended the adoption of last year as the alternative to LIBOR.

In its latest report, the ARRC acknowledges that the transition to SOFR will be difficult, given the volume of legacy contracts that reference LIBOR and do not have a fallback for its cessation. The ARRC observed that loan documentation typically implies that if LIBOR quotes are not published, the loan converts to an alternative base rate, such as the prime rate. However, because the prime rate is typically well above LIBOR, this would result in an unplanned and significant increase in borrowing costs.

The ARRC convened a working group to better understand the difficulties involved with the transition to SOFR and to conduct research into common forms of LIBOR-related contract language in the lending market. Working group members noted that loan contract language has begun to more robustly address economically appropriate fallbacks to LIBOR. The members also observed that there has been a movement by some market participants away from requiring unanimous consent of lenders to change the reference rate in syndicated loans.

View PDF version here.

The new report also provides for a paced transition plan to create a baseline level of liquidity for derivatives contracts referencing SOFR. The ARRC acknowledged that “end users cannot be expected to choose or transition cash products to a benchmark that does not have at least a threshold level of liquidity in derivatives markets.” The report lays out a transition plan, which concludes at the end of 2021 with the creation of a term reference rate based on SOFR derivatives. The intermediate steps are as follows:

• ARRC members will input infrastructure for overnight index swaps (OIS) and/or futures trading in SOFR in 2018.
• Trading in futures and/or bilateral, uncleared OIS that reference SOFR will take place by the end of 2018.
• In 2019, trading will begin in cleared OIS that reference SOFR in the current effective federal funds rate (EFFR) price alignment interest (PAI) environment.
• In 2020, central counterparties will begin allowing market participants a choice between clearing new or modified swap contracts in the current PAI/discounting environment or in one that uses SOFR for PAI and discounting.
• In 2021, central counterparties will no longer accept new swap contracts for clearing with EFFR as PAI and discounting.

The overarching goal of the paced transition plan is to progressively build the liquidity required to support the transition to and issuance of contracts referencing SOFR.