The Alternative Reference Rates Committee ("ARRC") outlined a plan for transitioning market reliance away from LIBOR, a move urgently needed due to the scarcity in underlying transactions. The ARRC previously recommended the Secured Overnight Financing Rate ("SOFR"), a Treasury repo index, as an alternative to LIBOR. In the latest report, the ARRC provided reasons for selecting SOFR as the LIBOR alternative and encouraged voluntary adoption of the rate.
In the report, the ARRC revealed that market activity referencing U.S. dollar LIBOR is 25% higher than previous estimates, and that around $200 trillion in U.S. dollar-based derivatives and loans are based on LIBOR. The FSB and FSOC have been wary of the decline in wholesale unsecured-term money market funding by banks, and had convened the ARRC to review the risks this trend poses. The ARRC endorsed the Secured Overnight Financing Rate ("SOFR") as a replacement; SOFR will be published daily by the Federal Reserve Bank of New York beginning on April 3, 2018.
As LIBOR is often used as a forward-looking term rate, and the chosen alternative rates are not forward-looking, the ARRC noted that it intends to develop a forward-looking term rate based on SOFR derivatives markets. Such a term rate may be futures-based, overnight index swap ("OIS") based, or based on actionable market quotes.
The ARRC intends to introduce and grow the demand for trading SOFR derivatives with a "Paced Transition Plan," consisting of the following steps:
ARRC members will input infrastructure for futures and/or OIS trading in the new rate in 2018.
Trading in futures and/or bilateral, uncleared OIS that reference SOFR will take place by end of 2018.
Trading will begin by 2019 in cleared OIS that reference SOFR in the current effective fed funds rate ("EFFR") price alignment interest ("PAI") and discounting environment.
CCPs will begin allowing market participants a choice between clearing new or modified swap contracts (swaps paying floating legs benchmarked to EFFR, LIBOR or SOFR) into the current PAI/discounting environment or one that uses SOFR for PAI and discounting beginning in 2020.
CCPs will no longer accept new swap contracts for clearing with EFFR as PAI and discounting, with some exceptions, in 2021.
By the end of 2021, a forward-looking term reference rate based on SOFR derivatives will be created.