Market indicators intended to undergird a term rate for an interest rate reference tool designed to replace a soon-to-be-discarded one was announced Thursday by a Federal Reserve group.
In a release, the Alternative Reference Rate Committee (ARRC), a group set up by the Federal Reserve Bank of New York, said the market indicators will be used in recommending a “forward-looking” secured overnight financing rate (SOFR), the tool the group is supporting to replace the London Interbank Offered Rate (LIBOR). LIBOR is scheduled to be discontinued at the end of this year; existing contracts using LIBOR after June 2023 will have to use a new reference rate.
The market indicators ARRC said it will consider in recommending the SOFR term rate are:
- Continued growth in overnight SOFR-linked derivatives volumes;
- Visible progress to deepen SOFR derivatives liquidity, consistent with ARRC “best practices,” which are:
- Offering electronic market-making and execution in SOFR swaps and swap spreads;
- Changing the market convention for quoting USD derivative contracts from LIBOR to SOFR;
- Making markets in SOFR-linked interest rate volatility products (including swaptions, caps, and floors);
- Visible growth in offerings of cash products, including loans, linked to averages of SOFR, either in advance or in arrears.
“The ARRC has long recognized that a forward-looking term SOFR rate will be a useful tool to support the transition away from LIBOR,” the group said in a release. “The publication of the indicators builds on the ARRC’s March 23 update, ongoing ARRC discussions, and term rate principles, and provides clear guidance that would allow the ARRC to recommend a SOFR-based term rate relatively soon.
“The indicators are designed to measure progress in establishing deep and liquid SOFR derivatives and cash markets – which are essential to a robust and stable term rate,” the group stated.
The group underscored that it has not yet recommended any forward-looking SOFR term rate or administrator and that it will continue to consider the proposals submitted to its request for proposals (RFP) to do so.
“Given U.S. supervisory guidance (referring to a Nov. 30, 2020, joint statement by federal banking agencies), the ARRC continues to encourage market participants not to wait for a term rate and to make use of current SOFR conventions available now,” the group stated.
Last year’s statement by the banking agencies encouraged banks to transition away from U.S. dollar LIBOR “as soon as practicable.”