Industry Update: Term SOFR Announcement and Next Steps
On July 29th, the Alternative Reference Rates Committee (ARRC) announced that it is now formally recommending the CME Group’s forward-looking Secured Overnight Financing Rate term rates (TERM SOFR). The ARRC’s formal recommendation of TERM SOFR is a major milestone in the transition away from USD LIBOR. These rates are officially published on the CME website. Union Bank launched TERM SOFR loan products on October 12, 2021. Similar to LIBOR, TERM SOFR is available by Union Bank in 1, 3, 6 and 12 month tenors. Click here for more information. For questions or inquiries related to the LIBOR transition please either reach out to your Relationship Manager or utilize the “Contact Me” button above.
What you need to know
This is a brief update of impending changes to the London Interbank Offered Rate (LIBOR). LIBOR has been a long-standing index for financial transactions and is currently the most commonly used variable interest rate index for short-term interest rates, business loans, variable-rate loans, financial derivative contracts, and other commercial lending products.
Things to keep in mind
LIBOR transition timeline
Frequently asked questions
What is LIBOR and why is it important?
The London Interbank Offered Rate (LIBOR) is the most commonly used benchmark for short-term interest rates and often is referenced globally in documentation for derivatives, bonds, business loans and consumer financial products. The setting of LIBOR is made daily on London business days by submissions of the average rates at which LIBOR panel banks believe they can obtain wholesale unsecured funding. It is estimated that $200 trillion of financial instruments (loans, bonds, derivatives and consumer financial products) are tied to LIBOR and that matters to everyone – small businesses, corporations, banks, broker dealers, consumers and investors.
What is happening with LIBOR and why transition away from it?
In March 2021, LIBOR’s administrator and regulator have confirmed the endgame for LIBOR. The ICE Benchmark Administration (IBA) will cease publication of the one-week and two-month USD LIBOR tenors immediately after December 31, 2021, and the remaining tenors (i.e., Overnight/Spot Next, 1-month, 3-month, 6-month and 12-month) immediately after June 30, 2023. The period between end-2021 and mid-2023 is primarily intended to allow legacy contracts to mature.
U.S. federal banking regulators have encouraged banks to cease entering into new contracts that use LIBOR as soon as practicable and in any event by December 31, 2021. The Alternative Reference Rates Committee (ARRC) also recommends no new LIBOR-based business loan contracts to be originated after June 30, 2021. Transition to alternative benchmark interest rates is well underway, but much work lies ahead to implement a successful reference rate change.
Additionally, as of December 31, 2021, the 1-week and 2-month LIBOR settings, will no longer be published.
What is the role of the ARRC?
In 2014, the U.S. Federal Reserve and the New York Federal Reserve Bank (NY Fed) established the ARRC to lead the transition away from LIBOR. It recommended the Secured Overnight Financing Rate (SOFR) as the replacement for LIBOR and encouraged the development of a SOFR futures market.
For the most recent information about the ARRC, please visit here.
What is SOFR?
In June 2017, the ARRC identified SOFR as the recommended alternative reference rate for LIBOR. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities (each a repurchase or repo transaction). While LIBOR is not fully transaction based, SOFR is based on an overnight repo market with ~ $1 trillion of transactions per day. The NY Fed is the administrator and producer of SOFR. Publication of SOFR began in April 2018. Trading and clearing of SOFR based futures and SOFR-based swaps began in 2018.
How is SOFR calculated?
SOFR is calculated as a volume-weighted median of transaction level tri-party repo transaction data, General Collateral Finance repo transaction data and data on bilateral U.S. Treasury repos cleared through Fixed Income Clearing Corporation's delivery-versus-payment service provided by DTCC Solutions LLC. SOFR is published each business day on the NY Fed’s website, while Term SOFR is published on the CME Group website.
Does the ARRC have a timeline for the adoption of SOFR?
In April 2021, the ARRC published its progress report on the transition from LIBOR, outlining key reference rate reform efforts, progress to date, and areas requiring further work. The “Progress Report: The Transition from U.S. Dollar Libor” also included the ARRC’s 2021 Objectives and Priorities to support a smooth and efficient transition from LIBOR.
In September 2020, the ARRC updated its recommended Best Practices for Completing Transition From LIBOR, originally released in May 2020. The ARRC’s Best Practices were intended to clarify the timelines and interim milestones for floating rate notes, business loans, consumer loans, securitizations and derivatives that the ARRC believed were appropriate for transitioning away from LIBOR in order to minimize market disruption and support a smooth transition to SOFR.
ARRC’s Recommended Best Practices for Completing the Transition from LIBOR can be found here.
For existing contracts referencing LIBOR and transitioning to SOFR, do any adjustments need to be made to SOFR to make the economics of the transaction comparable to those based on LIBOR?
As noted by the ARRC, LIBOR and SOFR have different characteristics, and where a LIBOR contract is falling back to SOFR, a spread adjustment will be added to make the rate more comparable to LIBOR. Therefore, the ARRC-endorsed fallback language provides for static spread adjustments that were fixed on March 5, 2021.
The fixed spread adjustments for LIBOR fallbacks are based on a 5-year historical median of the spread between the relevant LIBOR tenor and SOFR. The ARRC’s recommended spread adjustments for non-consumer cash products are the same as ISDA’s spread adjustments for LIBOR.
However, even with a credit spread adjustment, no replacement benchmark is likely to be neutral to all parties; some will benefit, and others will not.
What happens to existing transactions and contracts?
A transaction that references LIBOR or another interbank offered rate (IBOR) and matures or expires after the time LIBOR is expected to be unavailable will possibly need to be amended.
What is happening to new transactions entered into now and in the near future?
The ARRC recommended that no new LIBOR business loans maturing after 2021 be originated after June 30, 2021.
The ARRC, as well as trade associations and industry working groups, have developed contractual language to be included in contracts known as “fallback provisions” that specify what will happen when the benchmark rate it now references (such as LIBOR) is no longer available. Such provisions reflect industry standard terms and will also be incorporated into new contracts, unless parties explicitly agree otherwise.
What is a fallback provision?
It is a provision in the agreement for a loan, bond, derivative or another financial instrument specifying a new interest rate benchmark or negotiation process to be followed by the transaction’s parties to determine a replacement rate if the interest rate used in that contract becomes unavailable. The ARRC has recommended fallback provisions for new LIBOR-dependent syndicated and bilateral loans, floating rate notes, securitizations, and residential adjustable rate mortgages to help transition away from LIBOR when it becomes unavailable. Those recommended provisions can be found here.
Given that SOFR is an overnight rate, will forward looking term SOFR be available?
Yes, Term SOFR is now available in the following tenors: 1,3,6,12-month. On July 29, 2021, the ARRC formally recommended CME Group’s forward-looking SOFR Term Rates. The announcement was a milestone in the industry’s transition away from LIBOR, marking the completion of the Paced Transition Plan that the ARRC outlined in 2017.
Where can I get updates regarding the ARRC and the LIBOR transition process?
What is the current status of initiatives of the International Swaps and Derivatives Association (ISDA) for fallback language supporting LIBOR transition for derivatives (non-cash products)?
ISDA published an IBOR Fallbacks Supplement to its 2006 Definitions for derivatives contracts that became effective on January 25, 2021. New transactions that incorporate the 2006 ISDA definitions and reference LIBOR will incorporate fallbacks upon specified cessation events for such LIBORs to one or more “risk free” reference rates (each a fallback rate) together with a published spread adjustment.
ISDA also published the 2020 IBOR Fallbacks Protocol (the Protocol) on October 23, 2020 to enable market participants to amend their legacy uncleared derivatives and certain other contracts with other adhering parties to include the new fallback rates. The Protocol generally covers relevant IBOR transactions governed by ISDA master agreements, ISDA credit support documentation, subject confirmations, certain local law swaps and derivatives master agreements, repurchase agreements and securities lending agreements. ISDA has also published templates that parties may employ to bilaterally incorporate Protocol terms or to otherwise amend, include or exclude certain master agreements or transactions from the scope of coverage of the Protocol.
ISDA continues to publish additional materials for use by market participants to facilitate the LIBOR transition, such as new confirmation templates, updated and additional standard definitions, disclosures and matrices covering a range of provisions such as business days, floating rates, compounding and averaging terms, and cash settlement provisions. ISDA has published its ISDA 2021 Definitions, which will be implemented starting October 4, 2021. ISDA has also published a 2020 IBOR Fallbacks Protocol FAQ. The FAQ and additional information are available on the ISDA website.
Is MUFG actively working on the transition away from LIBOR?
Yes. MUFG established an enterprise-wide LIBOR Transition Office in 2019 to manage the transition for our customers and provide oversight for the company. In an effort to mitigate the risks associated with a transition away from LIBOR, MUFG has undertaken initiatives to: (i) develop more robust fallback language and disclosures related to the LIBOR transition, (ii) develop a plan to seek to amend certain legacy contracts to reference such fallback language or alternative benchmark rates, (iii) launch and enhance systems to support new products linked to alternative benchmark rates, (iv) develop and evaluate internal guidance, policies and procedures focused on the transition away from LIBOR to other benchmark rates and (v) prepare and disseminate internal and external communications regarding the LIBOR transition.
What should my company or business do right now?
(1) Learn more about LIBOR cessation, transition and replacement rate developments; (2) analyze your LIBOR exposure with a focus on financial instruments maturing beyond June 30, 2023 and what effect the discontinuation of LIBOR might have on that exposure; (3) engage with your counterparties, vendors and financial institutions to begin the process of identifying and amending LIBOR-dependent contracts; and (4) consider the impact that a change to a replacement rate may have on accounting, tax, IT, systems and operations.
Follow these links for news and other resources from some of the key industry participants in LIBOR transition:
Recent Industry Updates
This update follows the Alternative Reference Rates Committee’s (ARRC) formal recommendation of the SOFR Term Rate. The ARRC released best practice recommendations related to the scope of use of the CME SOFR term rates (SOFR Term Rate). The FAQs cover general questions about the scope of use, including why the recommendations were made, and more specific questions, such as the use of the SOFR Term Rate in end-user facing derivatives.
Proposed Path Outlines a Clear End Date for USD LIBOR; Would End New Issuances by End-2021, and Subject to Consultation Outcomes, Legacy Contracts Could Mature by Mid-2023
The Alternative Reference Rates Committee (ARRC) today applauded concurrent announcements by LIBOR’s administrator, its regulator, and U.S. regulators, regarding the proposed path forward for the transition away from U.S. Dollar (USD) LIBOR. The announcements include supervisory guidance encouraging banks to stop new USD LIBOR issuances by the end of 2021. They also cite plans to consult on specific timing for ceasing the publication of USD LIBOR, with proposed end dates immediately following the December 31, 2021 publication for the one week and two month USD LIBOR settings, and the June 30, 2023 publication for other USD LIBOR tenors.
TO SOFR OR NOT TO SOFR?
The OCC, Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation issued an Interagency Statement on Reference Rates for Loans reiterating that they are not endorsing a specific replacement rate for LIBOR. Banks may use any reference rate for loans they determine to be appropriate for their funding models and customer needs. The agencies said banks should include language in lending contracts that provides for using a robust fallback rate if the initial reference rate is discontinued.
Capital & Liquidity Memo Published
The ARRC published a memo summarizing its preliminary findings and recommendations about potential regulatory considerations associated with applying current and anticipated capital and liquidity requirements to the LIBOR transition.
ISDA announced the launch of the IBOR Fallbacks Supplement and IBOR Fallbacks Protocol, providing a framework for transitioning USD LIBOR interest rate derivatives to SOFR. 257 derivatives market participants signed on to the Protocol during a two-week "escrow" period.
Following four Credit Sensitivity work shops,official-sector leaders released a letter stating they do not plan to recommend a credit sensitive supplement to SOFR or credit-sensitive rates. They plan to hold two additional working sessions to further discuss the subject and explore related commercial loan transition solutions.
Freddie Mac issued its first SOFR-linked credit risk transfer deal (STACR REMIC 2020-DNA5) that uses 30-day average SOFR, but Freddie Mac intends to transition the transaction to an IOSCO compliant one-month term SOFR if and when it becomes available.
View archived articles here
Disclaimer: The areas and issues covered by this website are continually evolving and you should consult relevant sources and your advisors. Links to some of the relevant working and trade groups are incorporated in the information included on this website. MUFG makes no representation as to the accuracy, completeness or timeliness of such information, which may also be subject to change. The information provided herein is provided for informational purposes only, is not intended to be exhaustive and does not constitute, and should not be relied upon as, legal, regulatory, financial, tax, accounting or other advice. MUFG is not providing any such advice and does not act as your fiduciary. You should consult with your own advisors on the impact of the potential cessation of LIBOR on your business and affairs. MUFG does not warrant or accept responsibility for, and shall not have any liability with respect to, (a) whether the composition or characteristics of any alternative, successor or replacement rate to LIBOR (including SOFR) will be similar to, or produce the same value or economic equivalence of, or have the same volume or liquidity as, LIBOR or (b) the costs, expenses or the consequences related to the cessation of LIBOR or the transition to an alternative, successor or replacement rate thereto. None of the information contained herein represents a commitment or a firm offer to transact, nor does it obligate MUFG to enter into any such commitment.