Recent Developments on the LIBOR/SOFR Transition

What happened: On July 29, 2021, the ARRC announced that it is now formally recommending CME Group’s forward-looking Secured Overnight Financing Rate (SOFR) term rates after completion of a key change in interdealer trading conventions on July 26, 2021. 

Implications: With this announcement, all steps in ARRC’s Paced Transition Plan are now complete. As Tom Wipf, ARRC Chairman and Vice Chairman of Institutional Securities at Morgan Stanley stated in the release, “…This concludes the ARRC’s Paced Transition Plan and market participants now have all the tools they need as we enter the transition’s homestretch.”

What happened: On June 8, 2021, the Commodity Futures Trading Commission (CFTC) told brokers that facilitate derivatives trading among large banks that they should stop using LIBOR by July 26, 2021. The CFTC also recommends keeping the interdealer broker LIBOR linear swap screens available only for informational purposes until October 22, 2021.

Implications: This announcement may accelerate the push to phase out LIBOR. The ARRC believes that once this recommendation is adopted, market indicators for a SOFR term rate will have been met, allowing for CME SOFR term rates thereafter. 

What happened: On April 21, 2021, the CME Group began to publish CME Term SOFR Reference Rates for one-month, three-month, and six-month tenors in response to strong market demand for forward-looking term SOFR rates. The rates are aligned with the Alternative Reference Rates Committee's (ARRC) principles for recommended forward term rates. The CME Group intends to restrict the licensing of the SOFR term rates to cash market transactions until June 30, 2023 and the rates can be licensed at no charge until this date.

Implications: The development of term SOFR rates continue to support the growth and adoption of alternatives and replacements to LIBOR.

What happened: On March 29, 2021, the Alternative Reference Rates Committee (ARRC) published a white paper ​that outlines a model for using the Secured Overnight Financing Rate (SOFR) in asset-backed securities products. The paper describes how newly issued asset-backed securities (ABS), mortgage-backed securities, and commercial mortgage-backed securities could use 30-day Average SOFR with a monthly reset set in advance of the interest accrual period.

The ARRC continues to stress that now is the time for market participants to stop issuing new LIBOR-based products, including securitized products.

Implications: The model described in the white paper provides an example of how a successful SOFR-based ABS product could be created using Average SOFR. Widespread adoption of Average SOFR in ABS transactions can help stabilize the market during the LIBOR cessation and reduce systemic risk.

What happened: On March 23, 2021, the Alternative Reference Rates Committee (ARRC) announced it will not be in a position to recommend a forward-looking SOFR term by mid-2021. Accordingly, the ARRC urges market participants not to wait for a forward-term rate for new contracts but to instead be prepared to use available tools such as SOFR averages and index data that can be applied in advance or in arrears, as described in the User's Guide to SOFR.

Implications: As U.S. supervisory guidance encourages banks to cease entering into new contracts that use USD LIBOR by December 31, 2021, banks may not be in a position to wait for forward-looking term SOFR. Members can reference ongoing ARRC discussions and reports to continue migrating new activity into non-LIBOR instruments.

What happened: On March 5, 2021, ICE Benchmarks Administration and the U.K. Financial Conduct Authority announced cessation dates for all LIBOR rates. The one-week and two-month USD LIBOR settings will cease publication after December 31, 2021. All remaining dollar settings (overnight, one, three, six and 12 months) will cease publication after June 30, 2023. After June 30, 2023, one-month, three-month and six-month LIBOR may possibly be published on a “synthetic” basis and may be non-representative.

On March 9, 2021, the Alternative Reference Rates Committee (ARRC) confirmed that the March 5th announcements constitute a “Benchmark Transition Event” with respect to all USD LIBOR settings.

Implications: This action marks a significant step in the LIBOR transition process. Confirmed cessation dates allow institutions to continue migrating new activity into non-LIBOR instruments, as well as draw legacy LIBOR exposures to a close in an orderly fashion. 

What happened: On November 30, 2020, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued a statement to encourage banks to transition away from U.S. dollar (USD) LIBOR as soon as practicable. The ICE Benchmark Administration (IBA) announced it will consult on the end publication of various USD LIBOR tenors. If adopted, the plans would cease the publication of the one-week and two-month USD LIBOR settings after December 31, 2021 and the remaining USD LIBOR settings after June 30, 2023. 

Implications: Extending the publication of certain USD LIBOR tenors until June 30, 2023 would allow most legacy USD LIBOR contracts to mature before LIBOR experiences disruptions. These announcements propose a clear framework for ending USD LIBOR and would facilitate an orderly transition. The Alternative Reference Rates Committee (ARRC) updated their guide, which can be found here. 

What happened: On October 23, 2020, ISDA launched the IBOR Fallbacks Supplement and IBOR Fallbacks Protocol. The supplement amends ISDA’s standard definition for interest-rate derivatives to incorporate robust fallbacks for derivatives linked to certain IBORs.

Implications: This supplement reduces the systemic impact of a key interbank offering rate becoming unavailable while markets continue to have exposure to that rate. Effective January 25, 2021, all new cleared and non-cleared derivatives that reference the definitions will include the fallbacks.

What happened: On October 16, 2020, both the CME and LCH performed a coordinated single-day transition from discounting all cleared USD interest-rate swap products with the Effective Federal Funds (Fed Funds) to SOFR. The discounting switch was a pivotal step in the ARRC’s Paced Transition Plan for developing SOFR markets and marks a major milestone in the eventual discontinuation of USD LIBOR.

Implications: This transition impacted parties to clear swaps by introducing SOFR-discounting risk, as compared with their current exposure to Fed Funds discounting risk. The transition impacted the value of existing positions. The switch was intended to reduce risks and add momentum to the overall market transition away from LIBOR to SOFR. SOFR derivatives markets have seen increased activity and liquidity since the transition.

What happened: On September 10, 2020, the ARRC released a Request for Proposals seeking a potential administrator to publish forward-looking SOFR term rates. This follows the ARRC’s objectives to publish these rates in the first half of 2021 if liquidity in SOFR derivatives markets has developed sufficiently. The creation of SOFR term rates is the final step in the ARRC’s Paced Transition Plan.

Implications: Issuance of SOFR-linked products continues to increase, yet some markets have been slow to shift from LIBOR, citing the lack of a forward-looking term structure. This step taken by the ARRC is expected to lead to a solution for one of the biggest concerns. Greater trading volume in the SOFR futures market more likely will facilitate the creation of term rates, hence producing a curve thatreflects expectations for where rates will be in the future.

What happened: On August 7, 2020, the ARRC provided a set of factsheets, known as the “Starter Kit”, to inform the public about the transition away from U.S. dollar (USD) LIBOR to SOFR.  The SOFR Starter Kit includes the rationale behind the transition and the ARRC’s work to select a preferred rate, facts and figures about SOFR, and next steps market participants can take.  These factsheets follow the ARRC’s SOFR Summer Series, a collection of educational panel discussions:

• Part I: Background on USD LIBOR & History of the ARRC and the Selection of SOFR
• Part II: How SOFR Works & Common Misconceptions
• Part III: SOFR Best Practices & User Guide

Implications: As the need for implementation draws closer, the material provides a great foundation and resource for members to use to educate themselves on the cessation of LIBOR.

What happened: On July 1, 2020, the FFIEC released a statement emphasizing the importance of preparing for the discontinuation of LIBOR. The statement also noted that the supervisory focus on LIBOR exposure and transition will increase in 2020 and 2021, as LIBOR cessation approaches.

Implications: The FFIEC is composed of representatives from multiple regulatory bodies, including the Federal Reserve System, the Consumer Protection Financial Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the State Liaison Committee. This coordinated communication signals the significant efforts and attention being assigned to the LIBOR transition, even for institutions with minimal exposure.

Areas of emphasis that were noted include assessing LIBOR risk exposure in both on- and off-balance sheet instruments, addressing fallback language in contracts, identifying any effects to consumers, and evaluating the impact to third-party service providers.

What happened: On June 4, 2020, the Consumer Financial Protection Bureau (CFPB) provided guidance for consumers and regulated entities as the transition away from LIBOR continues. Notably, the CFPB updated their Consumer Handbook on Adjustable Rate Mortgages (CHARM). They also outlined the disclosures that must be provided when changing the index on an existing loan. Additionally, the bureau released a notice that credit card issuers and providers of home equity lines of credit will be permitted to replace LIBOR with a new index on or after March 15, 2021.

Implications: As adjustable-rate mortgages are an asset type that many members have exposure to, the guidance from the CFPB helps members provide their customers with the necessary information to understand the changes occurring with their existing loans.

The March 2021 date to replace LIBOR-indexed home equity lines of credit with a replacement index will give members the opportunity to reduce their LIBOR exposure ahead of the planned cessation date without waiting for loans to mature.

What happened: On May 27, 2020, the Alternative Reference Rates Committee (ARRC) released an article and factsheet outlining best practices as institutions continue to prepare for the cessation of LIBOR on December 31, 2021. These recommendations offer organizations guidance for a preferred timeline for fallback provisions, operational preparedness, and continued usage of LIBOR products. The best practices are categorized by instrument type, such as loans, securities and derivatives.

Implications: The guidance is another practical resource for members in assessing their preparedness for the LIBOR cessation. As December 31, 2021 gets closer, the focus on transition efforts continues to shift towards actual implementation and execution of previously outlined plans. This material provides a solid outline of target dates that members should be aware of.

What happened: On May 28, 2020, Fannie Mae and Freddie Mac jointly published LIBOR Transition Playbook sections to their respective websites. The websites contain timelines for various loan products and securities types, as well as Frequently Asked Questions. The agencies also announced they will cease issuing LIBOR-indexed Collateralized Mortgage Obligations (CMOs) no later than September 30, 2020, and will begin offering SOFR-indexed CMOs in June 2020.

On March 23, 2020, Freddie Mac announced that effective immediately, they will no longer issue unsecured debt instruments indexed to LIBOR.

Implications: The enhanced material and guidance serve to further increase transparency over the government-sponsored enterprises’ plans to ensure a smooth transition for the housing and mortgage markets they support. The issuance of SOFR-indexed CMOs will provide members who invest in CMOs an alternative structure to a familiar asset class.

What happened: On February 5, Fannie Mae and Freddie Mac announced they will no longer accept mortgage loans tied to LIBOR after December 31, 2020. In the second half of 2020, the agencies are anticipating that loans referencing SOFR will become eligible for delivery. They also indicated that at some point in 2021 they will cease purchasing loans that use a Constant Maturity Treasury (CMT) index.

Implications:  With a secondary market outlet for SOFR loans, originators may now have more support to expand their product lineup. Without Fannie and Freddie providing demand, the liquidity profile for LIBOR loans may weaken. The market is getting closer to seeing SOFR-based residential mortgage-backed securities, providing banks, credit unions, and insurance companies an option for a high-credit quality, cash-flow producing floating-rate asset.

What happened: On February 12, the Federal Reserve Bank of New York (New York Fed) announced that on March 2 they will begin publishing 30-, 90- and 180-day SOFR Averages, as well as a SOFR Index.

Implications: The New York Fed received considerable support for the publication of SOFR Averages and a SOFR Index. Greater visibility into the calculation of SOFR across a range of time periods supports the adoption of the index as a replacement to LIBOR. Progress continues to be made on the development of a forward-looking term structure for SOFR (for example, one-month or three-month SOFR, as opposed to the overnight index).

What happened: In January, the National Credit Union Administration (NCUA) released supervisory priorities which included a focus on how credit unionsare planning for the end of LIBOR.

Implications: Making sure all aspects of LIBOR exposure are identified, compliant, regulated and understood will be key for the NCUA during the LIBOR transition. Banking regulators are focusing on the LIBOR transition as well; in the Semiannual Risk Perspective for Fall 2019, the Office of the Comptroller of the Currency (OCC) highlighted the 2021 end date for LIBOR and noted that “the OCC is increasing regulatory oversight of this area to evaluate bank awareness and preparedness.”

What happened: Global issuance of SOFR-referenced debt has exceeded $250 billion, with the Federal Home Loan Bank System accounting for more than 50% of that amount. Large multinational banks have been accelerating the issuance of SOFR debt and community banks have issued subordinated debt issues with fixed to floating structures, using SOFR as the reference index for the variable-rate period. The U.S. Treasury has requested information from market participants to gauge interest in a floating-rate note referencing SOFR. SOFR options began trading and futures activity and participation continues to increase.

Implications: As the cash and derivatives markets for SOFR keep evolving and growing, participants of all shapes, sizes and business models can prudently reduce their exposure to LIBOR, while still meeting the ongoing asset and liability management needs of their balance sheet.

The growth in the market for SOFR-related corporate debt is a positive development for investors like insurance companies who rely heavily on corporate bonds in their investment portfolio. The use of SOFR in subordinated debt issuance affords community banks the ability to optimize their capital structure with their targeted interest rate exposure.

A SOFR-linked Treasury note could have a significant positive impact, spurring derivatives activity and serving as a benchmark for other debt issuers.

Increasing market adoption has allowed FHLBank Boston to develop new products such as the SOFR-Indexed Advance, as well as work towards reintroducing popular advance solutions like the Flipper Advance, without any reliance on LIBOR.

FHLBank Boston does not act as a financial advisor, and members should independently evaluate the suitability and risks of all advances.​