New York Fed to Publish SOFR Averages Index for LIBOR Transition
LIBOR is being phased out through 2021, and the Secured Overnight Financing Rate (SOFR) was selected as the preferred LIBOR replacement by the Alternative Reference Rates Committee (ARRC) in June 2017.
On March 2, 2020, the NY Fed will publish three daily compounding SOFR Averages with maturities of 30, 90, and 180 days, as well as a daily SOFR index, which will allow for the computation of compound average rates for custom tenors. Establishing tenor rates will go a long way towards helping corporate borrowers and hedgers navigate LIBOR replacement.
Why SOFR Averages Matter
The NY Fed plans to publish these compound average rates to facilitate the use of SOFR as a replacement for LIBOR as a benchmark rate beginning in the next several months. The hope is that these compound averages will be adopted for loans and floating-rate notes. The NY Fed believes that the adoption of the new benchmark rate for lending will further spur the adoption of the LIBOR replacement rate for interest rate derivatives.
SOFR averages will be compounded to reflect how interest is treated for derivatives as well as in the overnight repo market. They propose daily compounding as it better reflects the time value of money than a simple average, and the NY Fed believes this methodology will align better with the International Swap and Derivatives Association (ISDA) rate methodology used in overnight swap contracts. The SOFR rates will compound only on business days and accrue on an actual/360-day basis — which is the same as most derivative transactions — so that it encourages and supports the transition away from LIBOR.
The Securities Industry and Financial Markets Association (SIFMA) commented favorably on the NY Fed’s proposed SOFR indexes and averages. They said that it would be helpful for smaller organizations that did not have or could not find resources to calculate their SOFR tenors. They also thought that large institutions could use the published rates as a “double-check” of their calculations.
The NY Fed intends to publish new SOFR benchmark rates and curves in the first half of 2020. The curves will consist of 30-, 90- and 180-day tenors, plus a daily average compounded index rate, which can be used for custom tenors.
The expectation is that these rates will:
1) Allow and encourage LIBOR replacement for consumer loans and floating-rate notes
2) Provide rates for the interest rate derivatives market
3) Align with market conventions and ISDA overnight rate methodologies
Hedge Trackers will continue to keep our clients and interested parties aware of these and any other proposed market changes coming in 2020 and beyond. If you have any questions, please feel free to contact our team.