The Alternative Reference Rates Committee (“ARRC”) was first convened in November 2014 by the Federal Reserve Board and the Federal Reserve Bank of New York (in cooperation with the Department of the Treasury and the Commodity Futures Trading Commission) to identify a robust mark reference rate that could replace the London interbank offered rate (LIBOR) for US dollars.1 Although the committee believes that LIBOR’s weaknesses make it an undesirable reference rate for any financial product, the committee focused its work on the replacement of LIBOR in the interest rate derivatives market. On June 22, 2017, the ARRC announced that it had chosen the Secured Overnight Financing Rate (SOFR), a rate based on secured transactions in the overnight US treasury repo market, as its proposed replacement for LIBOR.
At a November 2, 2017, roundtable of the ARRC, Federal Reserve Governor Jerome Powell noted (in read remarks) that the ARRC had so far focused its work on derivative products, adding, “…[n]ow, however, market participants have realized that they may need to more seriously consider transitioning other products away from LIBOR.”2 Loans are one of the “other products” that will be considered by the committee. Governor Powell’s statement reflects in part concerns expressed by some participants in the US dollar loan market that, because SOFR is an overnight rate and (unlike LIBOR) not a term rate (i.e., a rate that is quoted for various periods of greater duration, such as one, two and three months), it would not be a good replacement for LIBOR.3
Speakers at the roundtable said the following about the ARRC’s new focus on loan products:4
- The membership of the ARRC will be reconstituted to include as participants banks and other “buy-side” investors in the “cash products” market. Cash products include corporate loans, floating rate notes, securitizations, CLOs, mortgages and consumer loans.
- The expanded committee will work to create “a term reference rate based on SOFR-derivatives markets.” Some participants at the November 2 roundtable expressed the view that such a term reference rate, although more robust than LIBOR, will not be as robust as SOFR itself.
- Because the ARRC believes that it should not create a term reference rate until there is sufficient liquidity in the SOFR-derivatives market,5 the committee anticipates introducing a rate by the second quarter of 2021, and completing the transition to a new rate by the end of 2021.6
- Some members of the ARRC expressed the view that, notwithstanding the committee’s work to develop a term rate, market participants could elect to price loan products at a rate based on SOFR.
Participants in the loan market will likely welcome the committee’s new focus on a reference rate for the loan market, but may be dismayed at the thought that the rate may not be developed until the end of 2021.
2 Introductory Remarks of Governor Jerome H. Powell at the Roundtable of the Alternative Reference Rates Committee, The Federal Reserve Bank of New York, New York, New York (via prerecorded video), www.federalreserve.gov/recentpostings.htm
3 See the October 30, 2017 letter from The Loan Syndications and Trading Association to the Board of Governors of the Federal Reserve System. https://www.lsta.org/advocacy-and-regulatory/comment-letters-and-papers
4 The written materials from the roundtable can be found at: https://www.newyorkfed.org/arrc/meetings
6 The U.K.’s Financial Conduct Authority has announced that after the end of 2021 it does not intend to persuade or compel banks to submit LIBOR quotations. Speech by Andrew Bailey, Chief Executive of the Financial Conduct Authority, on July 27, 2017. https://www.fca.org.uk/news/speeches/the-future-of-libor