As you likely know by now, in July 2017 the U.K.’s Financial Conduct Authority announced that LIBOR will be phased out by 2021. However, as we previously advised in our September 2017 Alert, lenders need not rush into replacing LIBOR for a new substitute index, as there is an ongoing process to facilitate an orderly transition in the market to a new, replacement index rate in place of LIBOR.
On April 13, 2018, the Federal Reserve Bank of New York (the “New York Fed”) began publishing three new reference rates based on overnight repurchase agreement transactions collateralized by Treasury securities. These new reference rates are the Broad General Collateral Rate (BGCR), the Tri-Party General Collateral Rate (TGCR) and the Secured Overnight Financing Rate (SOFR). The Alternative Reference Rates Committee formed by the Federal Reserve to address LIBOR replacement has identified SOFR as a potential candidate for the LIBOR replacement. The New York Fed describes SOFR as a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. SOFR includes all trades in the BGCR plus bilateral Treasury repurchase agreement (repo) transactions cleared through the “delivery-versus-payment” service offered by the Fixed Income Clearing Corporation, which is filtered to remove a portion of transactions considered “specials” (repo transactions for specific-issue collateral which take place at cash-lending rates below those for general collateral repos because cash providers are willing to accept a lesser return on their cash in order to obtain a particular security).
The New York Fed will publish such rates each morning at approximately 8:00 a.m. Eastern Time and will include statistics summarizing the distribution of volumes each day, including the total dollar amount of transactions used to calculate each rate, rounded to the nearest billion, and the volume-weighted 1st, 25th, 75th, and 99th percentiles.
While SOFR will not be a direct substitute for LIBOR because it is a secured overnight rate and thus lower than LIBOR, the publishing of this SOFR as a reported index rate is an important milestone in the development of a market for a new reference rate.
The takeaway for lenders is to continue monitoring the loan market for adoption of a replacement index rate to LIBOR and continue observing how the discontinuance of LIBOR impacts both existing and new loan documentation.