News Details

From LIBOR to SOFR
Sunday 1, April 2018

From LIBOR to SOFR

Lisa Updated

 

There have been countless discussions had on LIBOR and the proposed alternative SOFR and how the proposed changes will unfold.  The regulators have been in discussion about the LIBOR- London Interbank Offered Rate and its replacement SOFR – Secured Overnight Financing Rate for years. The New York Fed will start to publish the SOFR rates on April 3rd, 2018, so let’s look at what this means for the global financial market.

 

LIBOR stands for London interbank offered rate, the interest rate at which banks offer to lend funds to one another in the international interbank market.  It is a key benchmark rate that reflects how much it costs banks to borrow from each other on an unsecured basis, this assists businesses all around the world to price  mortgages, student loans, commercial loans, bonds and derivatives just to name a few.  This measurement allows customers of institutions to compare pricing and determine if the rates being charged to them are competitive in this every changing market.

 

SOFR is a secured overnight rate derived from collateralized or backed assets (Repos) trading in large volume. It comprises a wide range of overnight Treasury repo trade activity in a secured way, making it a benchmark for a number of transactions for institutions including money market funds, asset managers, broker-dealers, insurance companies and pension funds.

 

Why the change?

Your memory would not have to be that good to recall the LIBOR scandal that involved so many companies, with one trader referring to it as a cartel.  The scandal blighted the reputation of well-respected institutions such as Barclays, Deutsche Bank, JP Morgan, Royal Bank of Scotland and Citigroup.  As a result, U.S. and European lenders implicated, were forced to pay billions of dollars to settle rigging and other charges.  Mervyn King, the former governor of the Bank of England said this of LIBOR, "It is in many ways the rate at which banks do not lend to each other, it is not a rate at which anyone is actually borrowing."  Indeed, it is said that very few banks were actually making any unsecured loans.  This is why it was so easy to manipulate the rate.  In essence, the LIBOR manipulation showed that banks were falsely increasing or decreasing their rates in some instances to profit from trades and in others to improve their creditworthiness. Unlike LIBOR, since SOFR is based on real rates, it is less subject to manipulation. In addition, SOFR is an overnight rate, based on overnight loans; Libor, on the other hands, covers loan maturities ranging from one day to one year. SOFR is also based on far larger trading volumes.

 

 

The Federal Reserve in 2014 met to develop and identify a new reference rate of measurement after the loss of confidence in the LIBOR rate.  There were other measures considered but SOFR won out.  Since then the industry leaders and policymakers have been working together to phase out Libor by the end of 2021. The Fed’s Alternative Reference Rates Committee (ARRC) announced SOFR as its preferred fallback rate. Investors in securities, loans, futures and derivatives that currently use LIBOR will need to transition to SOFR-benchmarked products over time.

 

The transition is favored by most of the global investors, and the question asked is how to move from LIBOR to a SOFR-based benchmarks and indexes. The transition needs to be undertaken with tremendous care and in a timely manner so as not to interrupt business across the industry: buy and sell-side, exchanges, regulators, industry bodies, stakeholders to name a few.

 

One wonders what the effect of this implantation will have on financial products and transactions.  For now it remains to be seen.  It has been reported that people are reluctant to move away from LIBOR - maybe it is a case of sticking to what you know, and of course, many of the long term financial contracts spell out the use of LIBOR and it will take time to revise the terms and the language for these instruments.  What we do know, though, is that the U.S. is moving much faster than the U.K. in moving away from Libor, which may be as a result of many of their municipalities being negatively impacted by the manipulation of Libor.

 

Lisa Minto-Powell is the Assistant Vice President, Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

 

Share |
Go Back to News Archive
Document Library

You may browse and download our Customer Forms, Articles and other documents here.

 

Faqs
  • Q: Can I access any application forms online?
    A:  Yes, all application forms are available on our website.
  • Q: How easily can I encash all or part of my investment?
    A:  You may encash your investment at any time, however if you encash before the end of your tenure a penalty is applied.