At the SOFR Symposium hosted by ARRC on 11 May Andrew Bailey, the Governor of the Bank of England, took aim at the credit sensitive rates that some in the USD market are considering as a replacement for USD LIBOR.
In his speech, in relation to credit sensitive rates Bailey said:
“While these rates may offer convenience as a short-term substitution, they present a range of complex longer-term risks. And while they may remove the reliance on expert judgement, they veneer over the fundamental challenges of thin and incomplete markets through the extrapolation of data. The ability of such rates to maintain representativeness through periods of stress remains a challenge to which we have not seen adequate answers.”
The extent to which Bailey’s voice holds sway in the US market is a fair question, though it was clear from the Symposium that John Williams from the NY Fed was singing from the same hymn sheet. The UK experience does differ from the US in that the market already benefited from a well-established risk-free rate in the form of SONIA. That was always going to make the transition from GBP LIBOR to SONIA easier than from USD LIBOR to SOFR.
At the end of April ARRC released a statement on the principles for their recommendation of a forward-looking SOFR term rate, followed by a further statement in early May on the market indicators they will use to measure ‘deep and liquid SOFR’ markets. The statements did not say much that was new, highlighting that the rate needed to be rooted in a robust base of transactions (read much better SOFR liquidity than exists today), and importantly “have a limited scope of use” i.e. like Term SONIA in UK, intention is it will only be permitted in certain ‘use cases’, e.g. some legacy cash products.
Meanwhile across the pond progress is looking promising in Sterling – today saw the switch to “SONIA first” for non-linear derivative products, following on from the equivalent step for linear GBP LIBOR swaps last year. At an ISDA conference yesterday Edwin Schooling Latter, Director of Markets and Wholesale Policy at the Financial Conduct Authority, said “the time has come to put the foot on the accelerator”.
It will be interesting to see who wins the USD race – with the push to see “meaningful transition” between June and December this year (based on the ARRC best practices guide) and a hard mandate to cease new trading of USD LIBOR by the end of the 2021 (with the risk management exception for derivatives), things are starting to hot up.
In Bailey’s analogy we are coming-down off the LIBOR mountain, but he noted “the hardest part of mountaineering is the descent”.
1 SOFR Secured Overnight Financing Rate
2 ARRC Alternative Reference Rates Committee
3 USD LIBOR US Dollar London Inter-Bank Offered Rate
4 BSBY Bloomberg Short-Term Bank Yield Index
5 Ameribor American Interbank Offered Rate
6 SONIA Sterling Overnight Interbank Average Rate
7 ISDA International Swaps & Derivatives Association