No guarantee on forward-looking LIBOR alternative SOFR in 2021, group says

A group developing an alternative interest rate reference tool “will not be in a position” to recommend a forward-looking rate by the middle of this year, the group said Tuesday, adding it also encourages market participants to continue to transition from the popular reference rate being used now by employing the tools currently available.

In a release, the Federal Reserve Bank of New York’s Alternative Rate Reference Committee (ARRC) also said it cannot guarantee that it will be able to recommend an administrator that can produce a “robust forward-looking Secured Overnight Financing Rate” (SOFR) by the end of the year.

“Accordingly, the ARRC urges market participants not to wait for a forward-looking term rate for new contracts, but to instead be prepared to use the tools available now, such as SOFR averages and index data that can be applied in advance or in arrears, as described in the User’s Guide to SOFR,” the group said.

The ARRC has developed the SOFR to be a replacement for the soon-to-be discontinued London Interbank Offered Rate (LIBOR), which will no longer be guaranteed by the group that administers it (the ICE Benchmark Administration [IBA]) after the end of this year. Additionally, the federal banking agencies have told the institutions they supervise that entering into new contracts that use U.S. dollar (USD) LIBOR as a reference rate after Dec. 31, 2021, would create safety and soundness risks. “Therefore, the agencies encourage banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021,” the agencies wrote to banks in November.

On Monday, Federal Reserve Board Vice Chair for Supervision Randal Quarles said “there is no scenario” in which LIBOR will continue past June 2023, the end of the phase-out period for use of the reference rate in legacy contracts.

Tuesday, the ARRC said that while trading activity in SOFR derivatives is growing, the committee is not now in a position to recommend a term rate with confidence based on the current level of liquidity in SOFR derivatives markets (which was a condition set by the group to recommend the term rate). “In addition,” it said, “the ARRC is still evaluating the limited set of cases in which it believes a term rate could be used. Robust underlying activity and a limited scope of use over time are important conditions to help ensure that a recommended term rate does not reintroduce the vulnerabilities that first prompted the transition away from LIBOR.”

The group said it encourages market participants to continue to transition from LIBOR using the tools available now.

In another development, on Wednesday the ARRC published a white paper on a suggested fallback formula for the USD LIBOR ICE swap rate. The paper describes a formula to calculate a fallback from the USD LIBOR ICE Swap Rate to a spread-adjusted SOFR swap rate. “Contracts that are indirectly linked to USD LIBOR through reference to USD ICE Swap Rates are not covered by existing fallback provisions,” ARRC noted.

According to ARRC Chairman Tom Wipf, the paper aims to aid market participants as they consider how to address the impact that the end of representative USD LIBOR will have for contracts referencing the USD LIBOR ICE Swap Rates.

ARRC Provides Update on Forward-Looking SOFR Term Rate

Suggested Fallback Formula for the USD LIBOR ICE Swap Rate