A while back, FT Alphaville wrote about how sterling Libor’s demise was causing all sorts of headaches for the UK’s financial services industry. But the problems we’ve had on this side of the pond are nothing compared with the situation we’re seeing play out in the US right now.
There are many reasons why the attempts to ditch dollar Libor are proving more difficult on the other side of the Atlantic. One of them is that there are multiple candidates vying to replace the doomed benchmark.
The UK’s Libor transition is not without its issues. But what’s helped is that a consensus has formed around the Sterling Overnight Interbank Rate, or SONIA, as the agreed-upon alternative.
The situation in the US is more complex, with several benchmarks all competing for the title of Libor successor. In turn, this is leading many market players to put off replacing Libor in their financial contracts as well as slowing the process to a widely approved alternative.
How the ARRC’s built
In theory, the winner has been picked by The Alternative Reference Rates Committee, or ARRC. The group, which is made up of the banks but convened by the Federal Reserve Board and the New York Fed, has led the transition effort. After a lengthy consultation, the AARC eventually settled on SOFR, or the Secured Overnight Financing Rate, as its recommended alternative to replace Libor. The New York Fed publishes the measure daily.
Yet, while SOFR has — like SONIA — garnered official endorsement, there’s a fundamental difference between the two (and it’s not just that the former is rather trickier to pronounce). Unlike SONIA, which is based on unsecured borrowing rates, the US rate is based on overnight borrowing in the repo market, where US Treasuries are used as collateral.
SOFR, so good?
It’s easy to see the attraction of choosing a rate based on the repo market. For starters, it’s massive, with more than $1tn-worth of transactions daily. So there’s far less chance of SOFR proving tricky to measure due to a paucity of activity — the deciding factor in Libor’s downfall.
That SOFR is produced by the New York Fed, as opposed to the British Bankers’ Association, which recorded Libor in its pre-scandal glory years, also lends it an air of kudos. When it comes to fixing, no financial metric in the world is watertight, but we’d trust a central bank a lot more than we would a trade body.
However, there are a couple of concerns. Critics argue that, while the repo market is where the likes of J.P. Morgan might fund themselves, there are thousands of banks in the US that rely on other sources of funding.
Readers with decent memories might recall that, during the autumn of 2019, the repo market became extremely volatile, with the rate soaring several hundred basis points above the federal funds rate. (For those who haven’t, or who don’t, see here.)
That bout of volatility led the Bank for International Settlements to claim…
Go to the news source: Libor’s US replacements: no one rate to rule them all