Not SOFR Away: LIBOR Transition Begins

Transitioning away from LIBOR is likely to be a complex, expensive, and multi-year process. An important step occurred on April 3rd, when the Federal Reserve Bank of New York began publishing the Secured Overnight Funding Rate (SOFR), a new benchmark rate aimed as a replacement for USD LIBOR. The publication of SOFR allows institutions to proceed forward – and those that begin acting now will have the advantage of shaping the outcome and maximizing the time available to limit the impact of transition on the firm and its clients.

SOFR is an overnight collateralized rate based on daily repo transactions, typically over $700 billion each day. It was chosen by the Alternative Reference Rates Committee (ARRC) as the recommended alternative to USD LIBOR. SOFR complies with the International Organization of Securities Commission Principles for Financial Benchmarks and is based on a robust underlying market, in line with the Financial Stability Oversight Council and Financial Stability Board’s mandate.

Many of the changes required to begin using SOFR are already in progress. This includes CME Group supporting SOFR futures trading and swaps clearing, as well as the Financial Accounting Standards Board proposing the eligibility of SOFR as a permissible US benchmark interest rate for hedge accounting. However, a large volume of work remains for individual financial institutions, and this work should now begin in earnest.

Institutions need to determine how best to use SOFR and if need be develop alternative rates. It is also important to inventory exposures, speed up product development, and mobilize for transition of existing portfolios of LIBOR products. In parallel, firms should also initiate a client outreach and education process to prepare clients for the transition of existing products and pipeline of new product options.