The Federal Reserve Bank of New York will begin publishing a series of backward-looking secured overnight financing rates (SOFR) in the first half of 2020. Cash markets have been clamouring for a term rate to replace Libor as the benchmark for floating rate loans.
Lorie Logan, deputy manager of the System Open Market Account, discussed the effort at the last Federal Open Market Committee meeting, minutes published on February 20 revealed. Staff at the New York Fed have already started work on publishing the rates, which Logan described “as a further step to support reference rate reform”.
Public comment will be sought later this year before publication begins in the first half of 2020.
Loan issuers may be forced to ditch Libor by the end of 2021, when banks will be allowed to stop submitting quotes for the scandal-plagued benchmark. The absence of a SOFR term rate, whether backward- or forward-looking, has aroused anxiety in the market for loans, which are typically pegged to three-month Libor rates.
“This is another positive development for SOFR that will encourage take-up of the rate by cash products,” says Ian Walker, an analyst at Covenant Review, an analytics firm with representatives on two of New York Fed-convened Alternative Reference Rates Committee’s (ARRC) working groups.
Randal Quarles, the Fed’s vice-chairman for supervision, first floated the idea of publishing a compound average of SOFR – which he dubbed SAFR, for secured average financing rate – in a speech at the New York Fed last July. He said SAFR would make it easier for cash markets to move away from Libor, but that it “would not be a competitor” to a forward-looking SOFR rate.
Meanwhile, the ARRC is working on a forward-looking term SOFR rate, which is expected to begin publishing by the end of 2021.
“The more [a rate] looks and feels like the way the market has been functioning, the higher the success will be,” says David Knutson, head of credit research for the Americas at Schroders. “If the market has been using forward-looking Libor rates for some time, then if that can be replicated on a SOFR or SAFR basis, then it’s more likely to be successful.”
The absence of an official term rate has led to the issuance of SOFR-linked cash products using home-brewed methodologies. Last June, the European Investment Bank issued a floating rate note with coupon payments linked to a backward-looking, daily compounded average of the UK’s sterling overnight index average. Fannie Mae followed suit in July, issuing $6 billion of floating rate notes that paid a daily average of SOFR over the prior quarter.
But more SOFR-linked issuance is needed to develop liquidity in the market. Schroders’ Knutson says the Fed’s move to publish an official term rate will promote issuance and ensure that liquidity does not split across rival rates. One such rival rate could be Ice Benchmark Administration’s proposed US dollar bank yield index, aimed at the cash market.
“If there isn’t a central guiding light in this uncertainty, it will foster a confusion and potentially a variety of interpretations, methodologies, or rates, and that’s negative for everyone in the market. The most efficient market would look to a rate that is widely recognised as ‘the rate’,” he says.