10 May SOFR the New LIBOR
The Secured Overnight Financing Rate (SOFR) Replaced LIBOR
For new transactions as of April 1, 2018. LIBOR will continue to be used for existing swaps and loans. Today, SOFR will be used to measure the cost of borrowing cash overnight collateralized by US Treasuries.
SOFR will be used to calculate everything from revolving credit lines, term loans, and other short-term bank financings.
To calculate the new LIBOR, The Fed decided to compile transactions form two distinct areas to create reasonable secured funding rates, based on actual repo transactions, filtering each rate appropriately (BGCR & TGCR).
The Broad General Collateral Rate (BGCR)
1) All tri-party “specific counterparty” repo transactions (counterparties are known to each other at the time of trade), collected from rates provided by the bank of New York
2) All bilateral “specific counterparty” repo transactions ( counterparties are known to each other at the time of trade), collected from rates provided by the bank of New York
The first overnight BGCR rate (4/1/18) was based on $362 million in transactions @ 1.77%
The Tri-Party General Collateral Repo Rate (TGCR)
4) All tri-party “specific counterparty” repo transactions (where the counterparties are known to each other at the time of trade, collected from the bank of New York.
The first overnight TGCR rate (040118 – 040218) was based on $329 million transactions @ 1.77%.
The Secured Overnight Financing Rate (SOFR)
5) 3 sets of rates used to calculate SOFR
SOFR is the volume weighted median of all three rates BGCR + TGCR + DVP = SOFR. SOFR is published every day at 8:00 AM.
The first overnight SOFR rate (040118-040218) was based on $849 million in transactions @ 1.80%
SOFR vs. LIBOR compare and contrast
SOFR As Reflection of Liquidity: using $849 million worth of transactions greatly increases the liquidity of the numbers used to calculate the SOFR rate. For more details read the ISDA Benchmark Report
SOFR Reflects actual transactions.
Every article on SOFR points out that it’s based on actual transactions. But LIBOR, set by the BBA was supposed to be actual transactions as well. The BBA asked Panel Banks “At what rate were you able to fund yourself in X currency this morning?” We can blame the roundness of earth for the difficulties – But not LIBOR itself.
USD LIBOR was set at 5:30 AM New York Time was always problematic. The US hadn’t even begun funding yet. In all fairness, 11:00 AM is midday for UK and Europe. But for USD, it barely reflected true funding rates.
The Term Rate Problem:
The repo rates collected are overnight rates. But to mimic LIBOR more completely we need 3-month rates. We need the whole term structure: o/n 1wk, 1mo, 2mo, 3mo, 6mo, and 1yr.
The difference in credit:
The SOFR rate has a higher credit quality because it’s secured by the bond posted as collateral. Whereas LIBOR rates are unsecured borrowings. SOFR should trade at a lower rate than LIBOR. We should expect to see changes in “raw” swap quote before CVA is added to the final tradable swap rate.
The documentation of existing loans:
Documentation changes will be required under certain conditions if LIBOR rate is not available. LIBOR is currently slated to be provided until 2021. With 5 years being the long end of the term loan market, there will be 2 yr swaps outstanding that need to be converted to calculation with SOFR. This will require new documentation.
Globalization of new IBOR’s
The U.S. is the fourth country to formally determine a new IBOR rate. GBP, EURO, CHF JPY LIBOR, JPY TIBOR and EuroYen TIBOR have already determined new rates. ISDA has put together a nice piece on the new IBOR’s which you can read here.
Summary & Conclusion
The infrastructure is in place. As data is collected on SOFR and its component rates BGCR & TGCR, we’ll be able to see if the resulting rate is any difficulties in the rates replacement for LIBOR.
This blog gives you the overview of the New LIBOR. More news to come – and you’ll see it right here.