As the deadline for the end of the London Interbank Offered Rate (Libor) looms at the end of 2021, a host of legacy issues and alternative rate choices remain on the table, members of an FIA Expo panel on short-term interest rate rates agreed.
But while the panelists presented concrete analyses on alternatives to Libor, a rate used for years to set loans and other key interest-rate dependent products, little clarity was evident on the next course of action.
The drive to replace the original Libor rate gained ground after it was tainted by an alleged manipulation scandal; the Intercontinental Exchange Benchmark Administration (ICE) took over its administration in 2014.
Anne Beaumont, partner, Friedman Kaplan Seiler & Adelman LLP, and head of her firm’s Libor transition task force, told the panel that there is much that remains to be done before the deadline, including implementing fallback language and tackling tough legacy issues (what happens when a loan contract has no provision to move to a rate other than Libor, for example).
Most importantly for a FIA audience, it also involves the transitioning of the cash and derivatives markets to Libor alternatives, Beaumont said.
In the meantime, the CME Group has endorsed the Secured Overnight Financing Rate (SOFR) as an alternative to rate Libor and is a member of ARRC, a group of representatives of major market participants and trade groups put together by the Federal Reserve Board and the New York Fed.
But the CME also continues to list and trade its popular Eurodollar futures, which are based on the three-month ICE LIBOR underlying rate.
Sean Tully, CME managing director of financial and OTC products, cited several milestones in the adoption of the SOFR rate. He said that since the CME began offering SOFR-based interest rate clearing, it has cleared some $300 billion worth in SOFR-based swaps by 300 counterparties.
In addition, average daily volume for one- and three-month SOFR futures at the CME is about 50,000 contracts per day this year, Tully said. In October it averaged 56,000, and so far in November it has averaged more than 95,000 per day. Over 94 percent of the open interest in SOFR interest rate futures is traded at the CME, he said.
Also constructive was a move by Fannie Mae to offer SOFR-based mortgages, something that Freddie Mac also plans to do, Tully said.
SOFR was designed by the Federal Reserve Bank of New York and the U.S. Treasury Office of Financial Research and is based on the cost of overnight borrowing of cash collateralized by Treasury securities. The New York Fed began quoting overnight SOFR rates in April 2018.
As if that was not complicated enough, there are other benchmark interest rate alternatives in the mix. Also on the panel was Richard Sandor, founder of American Financial Exchange (AFX) and Ameribor, an alternative rate based on the borrowing costs of a broad base of mostly small- and medium-size U.S. lenders.
Sandor said AFX is “just interested in the loan side” of the business, adding that Ameribor was “not an alternative to SOFR, it’s complementary.” But he added that “the more indexes the better.”
Bloomberg’s global head of index products, Umesh Gajria, also spoke. Bloomberg began publishing RFR rates, which are Risk Free Rates developed on a currency-by-currency basis, in July, he said. Bloomberg is also working on the issuance of a short-term rate index to be used as a guide for the marketplace, he said.
Lacking immediate agreement, “We should not get into a situation where every derivative is tied to one index,” Sandor said. “Cash markets will drive what the exchanges will do.”