Loan conventions and use cases for how to best use an alternative to a soon-to-be-defunct LIBOR reference rate were recommended Wednesday by a Federal Reserve-sponsored committee.
In a release, the Alternative Reference Rate Committee (ARRC), the group sponsored by the Fed that developed the Secured Overnight Financing Rate (SOFR) as an alternative to U.S. dollars (USD) LIBOR (London Interbank Offered Rate), said the recommendation was made to accelerate the transition away from LIBOR. That rate will no longer be used for new contracts beginning Jan. 1. LIBOR will be discontinued for existing contracts after June 30, 2023.
The committee said that its best practices highlight areas where use of SOFR term rates will be helpful to support a smooth transition away from USD LIBOR. “The SOFR Term Rates will be especially helpful for the business loans market—particularly multi-lender facilities, middle market loans, and trade finance loans—where transitioning from LIBOR to an overnight rate has been difficult,” ARRC said.
“The best practice recommendations also support the use of SOFR term rates in end-user facing derivatives that hedge cash instruments linked to the Term Rates, and certain securitizations with underlying assets that are themselves tied to SOFR term rates,” the committee added.
According to ARRC, the release of the loan convention best practices is the next step toward the last: the formal recommendation of SOFR by the committee, which would make the term rates widely available. The group said that recommendation is expected to follow shortly after the July 26 move of interdealer trading conventions to SOFR.
The group said once the SOFR first swaps convention switches on July 26 and the committee formally recommends the SOFR term rates, “market participants should have what they need to use SOFR in all its forms across financial markets, including the use of the SOFR Term Rates for business loans.”
Also Wednesday, ARRC said it had endorsed the Commodity Futures Trading Commission’s (CFTC) market risk advisory committee’s (MRAC) recommendations that inter-dealer trading conventions for cross-currency basis swaps between USD, Japanese yen, U.K. pound sterling and Swiss franc LIBOR move to each currency’s risk-free rate (RFR) as of Sept. 21. That July 13 step, ARRC said, is the second phase of MRAC’s recommended SOFR first initiative.
ARRC Recommends Loan Conventions and Best Practices for Use of Forward-Looking SOFR Term Rate