September 24, 2019 - “Some say only two things in life are guaranteed: death and taxes. But I say there are actually three: death, taxes, and the end of LIBOR.” – John Williams, President Federal Reserve Bank of New York, September 23, 2019.
On Monday, the FRBNY President opined on the future (or lack thereof) of LIBOR and warned the naysayers about “sticking their metaphorical heads in the sand, hoping the issue will go away.” At the same time, at ABS East, the LSTA’s Meredith Coffey and Ellen Hefferan – and a suite of experts –were discussing how financial products can survive the death of LIBOR. To that end, IMN and the LSTA developed a progressive four-session series that discussed: i) LIBOR cessation from six critical vantage points, ii) what SOFR really is and how it would be used, iii) the implementation of LIBOR fallback language and iv) the operationalization of SOFR in loan and other systems. We offer key takeaways (and charts) below and remind readers that we will offer a similar track at the LSTA Annual Conference on October 30th in NYC.
At the ABS East “LIBOR Crossroads” session, we discussed transition from six different perspectives: i) the official sector view, ii) the implementation view, iii) the UK view on issuance, iv) the US view on issuance, v) the rating agency challenge and v) the borrower/issuer/legal view. Our takeaways: 1) The government is on it. Treasury has indicated there may be tax help on the way (and has even discussed SOFR issuances), the banking regulators speak out regularly (see above), the SEC has provided guidance and the FSOC debates the issue regularly. 2) While many institutions are nowhere near ready, there are resources available. In fact, on September 19th, the ARRC published a “Practical Implementation Checklist”. 3) The UK securitization market has basically switched to SONIA; the rate underpins 85% of securitization issuance in the past six months (see slide 6). 4) The US is moving along; there has been over $236 billion of SOFR issuance since last July and the pace is accelerating (see slides 7-8). 5) The ratings implications are significant on the ABS front; there are some 14,000 ABS transactions and all have to be reviewed for uncertainty and basis risk. 6) On a legal side, “people would have to be insane to issue instruments without fallbacks.” (As noted here, fallbacks are definitely being used in loans and CLOs; we’d encourage the market to get to hardwired fallbacks as soon as possible.)
The hardwired fallback should get loans and CLOs to SOFR…but which SOFR? In the “Understanding SOFR” panel, we discussed the general types and attributes of different SOFRs. First, there are SOFRs where one knows the rates in advance and which look and feel much like LIBOR, e.g., Forward Looking Term SOFR and SOFR Compounded in Advance. Then there are those SOFRs where one doesn’t know the rates in advance, e.g., SOFR Compounded in Arrears and Simple Daily SOFR in Arrears. We laid out the definitions on slide 6 and the pros and cons of each on slides 7-8.
And we discussed how one goes about operationalizing these different SOFRs in the “Operationalizing SOFR” session. Slide 4 does a spectacular job of laying out the Commercial, Technology and Process changes that must occur to operationalize each of them. Unsurprisingly, the SOFRs that look and feel like LIBOR – e.g., Forward Looking Term SOFR and SOFR Compounded in Advance – have far fewer Commercial, Technology and Process changes. Those that involve pulling a rate (Simple Daily SOFR in Arrears) are more complicated and further compounding that rate (SOFR Compounded in Arrears) is more complicated still. Nevertheless, the operations working groups, banks and vendors plan to operationalize all four variants to ensure usability across loan markets and jurisdictions. The LSTA is on the ARRC itself and co-chairs the ARRC’s Business Loans Working Group. If members have questions on LIBOR transition, please contact email@example.com for policy and market issues, firstname.lastname@example.org for documentation issues and email@example.com for operations issues.