May 11, 2021 - by Meredith Coffey. On May 11th, the Alternative Reference Rates Committee (“ARRC”) held its second “SOFR Symposium”, sharing opinions of central bankers (Federal Reserve Bank of New York and Bank of England), lenders (JP Morgan, Wells Fargo and Morgan Stanley) and borrowers (Ford, Prologis and AFP). Three key messages emerged: 1) Term SOFR is coming (soon). 2) SOFR is the most robust, sustainable replacement rate out there for USD LIBOR. 3) But we may well be living in a multi-rate world, including Credit Sensitive Rates (“CSRs”) where necessary.
John Williams, President of the Federal Reserve Bank of New York (“FRBNY”) and Andrew Bailey, Governor of the Bank of England (“BoE”), kicked things off by explaining why SOFR (and SONIA in the UK) are the primary replacement rates for LIBOR. To wit, overnight risk free rates (like SOFR) are safe, resilient and transparent. SOFR, itself, is underpinned by roughly $1 trillion underlying daily treasury repo trades. The central bankers noted that other potential replacement rates do not have the depth of underlying transactions – and those underlying transactions saw disruptions in in March 2020. (This point was underscored on Slide 4 of the ARRC’s “Guide to Published SOFR Averages”, which shows the daily volumes of SOFR underpinnings ($1 trillion), 1-4 day AA Financial CP ($7 billion), and 3M Bank CP ($ billion) and CDs ($1 billion). After making the case for “SOFR-the-concept”, the BoE and Fed officials added that Term RFRs (like Term SOFR) have a role to play in a new, post-LIBOR world.
Official sector theory is one thing but, practically speaking, how quickly do we really get to Term SOFR? The next panel, comprised of bank lenders (JPM, Wells and Morgan Stanley) argued that we should get to Term SOFR quickly. (Indeed, we’d editorialize that the CME has launched a live, licensable Term SOFR rate.) As we discussed last week, the ARRC has published principles and market indicators that would enable the ARRC to quickly recommend a Forward Looking Term SOFR. Importantly the indicators are: 1) Continued growth in overnight SOFR derivatives volume; 2) visible progress to deepen SOFR derivatives liquidity; and 3) visible growth in SOFR cash products offerings, including loans.
Based on those indicators, an ARRC recommended Term SOFR may be “readily achievable”, bankers said. First, SOFR derivatives activity has climbed 15% in past month and is up 50% in the last three months. Second, there has been a lot of work – particularly in the CFTC’s Market Risk Advisory Committee – to deepen liquidity. And, third, there are SOFR loans out there.
One bank noted that they have been doing SOFR loans – Daily Simple, Daily Compounded and Compounded in Advance – for months. They further added that, per their experience, the entire loan market did not need Term SOFR, but a number of loan market participants want a forward looking Term SOFR – and should have it soon. However, another bank added, the lack of a forward looking Term SOFR has put SOFR at a disadvantage; people might go to other alternatives (like CSRs) because they want a term rate, not because they necessarily need credit sensitivity. Still, the solution set likely includes all versions of SOFR – including Term SOFR – along with CSRs where they are warranted.
How does all this sit with borrowers? Ford, AFP and Prologis weighed in. Perhaps unsurprisingly, according to an AFP survey, corporates haven’t lined up behind CSRs: 77% expect some form of SOFR to be the main replacement rate. (The likely reason that a number of banks like CSRs and borrowers don’t may be because CSRs rise in periods of market volatility while SOFRs remain flat or fall.) Still, Ford noted that there is no “one size fits all” solution, so there needs to be multiple SOFR alternatives. Prologis, who has been trying to do a SOFR loan, added that Term SOFR is ideal as it helps them manage their cash flow.
Bottom line: Term SOFR is coming (quickly), so don’t lose hope. The speakers acknowledged that the loan market is not a monolith and different segments may need different forms of SOFR – or CSRs – as appropriate. And, finally, there likely will be multiple reference rates in the future, so we simply must prepare for that eventuality.