The financial industry and global regulators have transitioned from the London Interbank Offered Rate (LIBOR) to more robust alternative reference rates.
As part of the transition away from LIBOR, regulated entities ceased executing new LIBOR transactions on December 31, 2021, and the U.S. dollar LIBOR bank panel ceased on June 30, 2023.
LIBOR’s regulator, the Financial Conduct Authority in the U.K., announced in April 2023 that the 1-, 3- and 6-month U.S. dollar LIBOR settings will continue to be published using a synthetic methodology until September 2024 to ensure a smooth final transition. Firms must prepare for these final synthetic LIBOR settings to end on September 30, 2024.
Before the transition, LIBOR was the most used benchmark for short-term interest rates, often referenced globally in derivative, bond and loan documentation. It was estimated that $223 trillion of financial contracts and securities were once tied to USD LIBOR.
LIBOR was informed primarily (and sometimes entirely) by “expert judgement” from estimates of transactions – not actual transactions – and, as a result, did not necessarily reflect the true cost of bank funding, making it vulnerable to volatility and manipulation. Over a decade ago, global regulators saw the problem with placing the foundation of the global financial markets on such a construct, which led to the phasing out of LIBOR and the transition to alternative reference rates including the Secured Overnight Financing Rate (SOFR).
The Transition to SOFR
Through the Alternative Reference Rates Committee (ARRC), the Federal Reserve Board and New York Federal Reserve gathered over 300 institutions, including SIFMA, to work on issues including legacy transactions, implementation of robust fallback provisions, and development of term rates in support of a successful transition to alternative reference rates.
In 2017, the ARRC issued a recommendation that the Secured Overnight Financing Rate (SOFR) would be the preferred, robust alternative to LIBOR. SOFR is a fully transaction-based rate, referencing the previous day’s activity in the repurchase markets. SOFR is based on approximately $1 trillion of daily transactions from a wide range of market participants and is administered by the New York Fed. SOFR is, by intent and construction, a reliable and representative indicator of market interest rates; it is published daily by the New York Fed. The ARRC followed this milestone with the development and publication of numerous recommendations, guidance documents, and reference materials for a successful transition away from LIBOR in line with its Paced Transition Plan.
The market has broadly accepted this work, as shown by the usage of ARRC recommended fallback language in new transactions, the issuance of significant amounts of debt referencing SOFR and the execution of trillions of dollars of SOFR-based swaps and futures contracts.
In November 2023, the ARRC released its Closing Report: “Final Reflections on the Transition from LIBOR”.