Principles released for setting forward-looking term rate in replacement of LIBOR

Recommendations for a forward-looking reference rate to replace a soon-to-be-defunct rate will be guided by a set of principles released Tuesday by a Federal Reserve-sponsored group, the group said.

In a release, the Alternative Reference Rate Committee (ARRC) of the Federal Reserve Bank of New York said the guiding principles are for recommending a forward-looking Secured Overnight Financial Rate (SOFR) term rate. The SOFR is the ARRC’s preferred rate for replacing the London Interbank Offer Rate (LIBOR), which is scheduled to be phased out at the end of this year (legacy contracts using the rate are scheduled to stop using the rate by mid-2023).

According to the ARRC, the forward-looking rate should meet the group’s criteria for alternative reference rates, be rooted in a robust and sustainable base of derivatives transactions over time and have a limited scope of use.

The group also advised market participants “not to wait for a term rate and to make use of current SOFR conventions available now.” ARRC added that it “has long recognized that a forward-looking SOFR term rate may be a supporting tool for certain uses in the transition, and has recommended a number of actions aimed at building liquidity in SOFR derivatives that would help to ensure the robustness of any recommended term rate.”

Key Principles to Guide the ARRC as it Considers the Conditions it Believes are Necessary to Recommend a Forward-Looking SOFR Term Rate