As a follow-up to our article on the phase-out of LIBOR (London Interbank Offered Rate), which is the primary benchmark for overnight borrowing costs for banks, as well as a base rate most often used in commercial lending and other loans, there has been some recent discussion regarding an extension of the deadline for banks to cease using the reference rate and transitioning to SOFR (Secured Overnight Financing Rate).
The Securities and Exchange Commission Chair, Gary Gensler, recently stated that the change from LIBOR to SOFR, “will happen with quite a high certainty and it will happen in a very short period of time,” because, as with many things, financial institutions will likely wait until the end of 2021 to make the transition.
While regulators have endorsed SOFR, which is based on overnight repurchase agreements that are secured by the U.S. Treasury, there are still some benefits which LIBOR has, that SOFR lacks:
- LIBOR, unlike SOFR, reflects credit risk since it is derived from London banks’ estimates of what they would be charged when borrowing from other banks.
- LIBOR can also be forecasted up to 12 months into the future, where SOFR has only recently been able to be used to predict future rate calculations.
However, it is being said by Alternative Reference Rates Committee (ARRC), a panel consisting of private market participants convened by the Federal Reserve Board and the New York Federal Reserve Board that “SOFR is a much more resilient rate than LIBOR because of how it is produced and the depth and liquidity of the markets that underlie it. As an overnight secured rate, SOFR better reflects the way financial institutions fund themselves today.”
While Gensler said, “most of the market adjusts pretty smoothly,” there still could be some instability during the transitional time. Therefore, it is a good idea that if you have a loan currently tied to LIBOR, that you begin talking to your lenders about this transition, and what it means to you.
To read more about ARRC and the transition from LIBOR to SOFR, visit https://www.newyorkfed.org/arrc/sofr-transition