Preparing to Implement SOFR
THE LEADERBOARD REPORT
Release Date: November 18, 2020
Participants: Aaron Hemphill, Scott Carrithers
Topic: Preparing to Implement SOFR
Click here to listen now, or read the transcript below:
Welcome to the latest installment of The Leaderboard Report. I’m Scott Carrithers, managing director for Country Club Bank’s Capital Markets Group.
In today’s Leaderboard Report, we will hear from Aaron Hemphill, who will share an update on the anticipated market transition from LIBOR to SOFR, slated for the end of 2021. Preparing for this transition is very important, and we want to make certain our clients stay on top of it.
Thank you, Scott.
As Investors in fixed income markets, many of us are very familiar with the “LIBOR” index.
The Capital Markets Group has sent communications over the last few years about the changes taking effect December 31, 2021. Taking the place of LIBOR –is a lesser known index called SOFR —Spelled S.O.F.R.—the Secured Overnight Financing Rate.
Today I’ll cover these three items:
First, what are the planned changes?
Second, what is SOFR?
How can you prepare for these changes?
Let’s begin with the planned changes.
On December 31st, 2021, the longtime and globally utilized interest rate benchmark LIBOR is scheduled to be eliminated. This may have broad implications on various markets, investors, lenders, and government agencies to name just a few.
In a March 25, 2020 statement addressing the potential impact of COVID-19 on LIBOR transition plans, the Financial Conduct Authority reemphasized that firms cannot rely on LIBOR being published after the end of 2021—and that this should remain the target date for all firms.
FHFA is working with its regulated entities to monitor their exposure as they execute their transition plans away from LIBOR. The FHFA’s regulated entities are now issuing SOFR-indexed debt.
Fannie Mae and Freddie Mac have announced they will stop accepting LIBOR-indexed adjustable-rate mortgages by the end of 2020. Additionally, both agencies recently began accepting mortgages tied to SOFR. The decision by Fannie Mae and Freddie Mac to move away from LIBOR and begin accepting SOFR ARMs is an important step in this transition.
So, what is SOFR? SOFR is an index rate based on overnight transactions in the U.S. Treasury secured repo market. This rate will be based on the transactions entered into on the previous business day. The rate is published daily by the Federal Reserve Bank of New York and is posted on their website along with Bloomberg. The updated rate is posted by approximately 8:00am EST. A link to this information is located in the email under the link to this report.
The Federal Reserve Bank of New York began publishing the SOFR benchmark in April 2018.
It was chosen after a rigorous evaluation determined it to be the best replacement—having exceptional liquidity, data transparency, and substantial volume with transactions totaling over $1 trillion a day.
The New York Fed also produces 30, 90, and 180-day averages of SOFR that can be used in contracts for various securities, investment products, and other financial instruments.
How can we prepare for these changes?
The Federal Reserve Board and the New York Fed have formed a group of participants called the Alternative Reference Rates Committee, or ARRC. This group of private-market participants contains a diverse set of banks, insurers, regulators, and asset managers.
This committee has been designated to manage the transition of the LIBOR benchmark to the new SOFR index and has provided numerous resources on their website that can help institutions prepare.
As mentioned, the first debt market to adopt SOFR has been floating rate securities issued by the Federal Home Loan Bank. Other financial products—such as loans—have begun to implement SOFR as well.
We highly suggest you look into products or services you may own or currently offer that are connected with the LIBOR index. It’s important to address any areas that may need amended fallback language and develop replacement procedures.
LIBOR has been an integral part of markets for quite some time. Several products, some currently sold by Country Club Bank Capital Markets Group, still rely on this index.
Again, the Alternative Reference Rates Committee has provided resources to update you and your bank on this process and the potential impacts to markets.
Links to this information are also included in the email for this Leaderboard Report. These reference tools share recommendations and best practices to plan for this transition.
We understand this transition will likely present a variety of challenges, and we are happy to address them any way we can. Please reach out to your Country Club Bank representative with questions regarding the SOFR transition or to discuss investment products currently available using the new SOFR index.
Thank you for your time.
Published SOFR rate from the Federal Reserve Bank of New York:
Best Practices and Timeline Implementation recommendations: