A new financial reference rate, published in 30-, 90- and 180-day averages, will be made public beginning March 2 as the “Secured Overnight Financing Rate” (SOFR), in a key step for replacing the London Interbank Offered Rate (LIBOR), the Federal Reserve Bank of New York (FRBNY) said Wednesday.
The bank said it will publish the averages in its role as administrator of SOFR. It will also publish a SOFR index. Both actions, the bank said, are being taken “in order to support a successful transition away from U.S. dollar (USD) LIBOR.” The new SOFR averages, the bank said, will be referred to as “30-day Average SOFR”, “90-day Average SOFR” and “180-day Average SOFR.”
The bank said it was moving forward on publishing the averages after receiving “broadly supportive” feedback from a comment period beginning Nov. 4 on proposed calculation and publication of the averages and index.
According to the FRBNY, the SOFR averages and index will employ daily compounding on business days, as determined by the SOFR publication calendar (each business day that is not broadly recognized as a holiday by the Securities Industry and Financial Markets Association (SIFMA) calendar for U.S. government securities). Simple interest will apply to any day that is not a business day, at a rate of interest equal to the SOFR value for the preceding business day, the bank said.
SOFR was officially adopted by the Fed in December 2017 as a replacement for the venerable – but deteriorating in effectiveness — LIBOR, which has been widely used by financial institutions as a basis for setting (among other things) variable rate loans. The Consumer Financial Protection Bureau (CFPB) has estimated that there is $1.3 trillion in consumer loans with an interest rate based on LIBOR, the bulk which are for residential mortgages.
LIBOR is being phased out, according to CFPB, because the rate is based on transactions among banks that don’t occur as often as they did in prior years, making the index less reliable and credible. Indeed, according to CFPB, the United Kingdom regulator that oversees LIBOR has stated that it cannot guarantee LIBOR’s availability beyond the end of next year.
The Federal Reserve has also urged financial institutions to begin adopting the new benchmark SOFR.
SOFR was developed by the Alternative Reference Rates Committee (ARRC) convened by the Federal Reserve. The rate is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities. Specifically, according to the FRBNY, SOFR includes all trades in the “Broad General Collateral Rate” plus bilateral Treasury repurchase agreement (repo) transactions cleared through the Delivery-versus-Payment (DVP) service offered by the Fixed Income Clearing Corporation (FICC), which is filtered to remove a portion of transactions considered “specials.”