May 6, 2021 - by Tess Virmani. Today the ARRC announced the market indicators that would enable the ARRC to recommend a forward-looking term SOFR (“Term SOFR”). Today’s announcement should calm fears stoked by the ARRC’s statement this Spring that it would be unable to recommend a Term SOFR by the end of June (the targeted date) or possibly by the end of this year (when regulators strongly recommend that LIBOR loan originations end). Today’s announcement states that the market indicators build on the ARRC’s earlier statements and “provides clear guidance that would allow the ARRC to recommend a SOFR-based term rate relatively soon.”
The ARRC has consistently made clear that it would only be able to recommend Term SOFR as a reference rate if that benchmark were IOSCO compliant, which in this case requires sufficient SOFR derivatives volume to support the expected usage of that reference rate. (As a reminder, CME launched an IOSCO compliant Term SOFR rate in April.) Robustness of a recommended Term SOFR is the tenet at the heart of the ARRC principles guiding its recommendation. Today’s announcement swiftly follows – as the ARRC promised – the ARRC’s release of those principles a few short weeks ago and are focused on ensuring robustness and stability of Term SOFR.
What are the market indicators?
- Continued growth in overnight SOFR-linked derivatives volumes
- Visible progress toward ARRC best practices designed to deepen SOFR derivatives liquidity:
a. Offering electronic market-making and execution in SOFR swaps and swap spreads
b. Changing the market convention for quoting USD derivative contracts from LIBOR to SOFR
c. Making markets in SOFR-linked interest rate volatility products (including swaptions, caps, and floors)
- Visible growth in offerings of cash products, including loans, linked to averages of SOFR, either in advance or in arrears.
We particularly flag point 3, which reflects an action that can be taken by the loan market. Taken together, the indicators are reflective of “progress in establishing deep and liquid SOFR derivatives and cash markets” – an outcome all prospective users of Term SOFR should desire. As Tom Wipf, ARRC Chairman and Vice Chairman of Institutional Securities at Morgan Stanley, reiterated in his press statement, the indicators are achievable in the near term “if market participants continue to accelerate their move away from LIBOR to SOFR derivatives”.
Bottom line: The ARRC’s recommendation of Term SOFR is proving not as elusive as feared. In fact, if SOFR transition efforts continue, it could be here before we know it.
Looking ahead: Members are encouraged to tune in to the ARRC’s upcoming SOFR Symposium on May 11th where the fate of Term SOFR is sure to be highlighted.