Federal Reserve Bank of New York (“NY Fed”) Senior Vice President Lorie Logan discussed the future of the London Interbank Offered Rate (“LIBOR”) and the NY Fed’s efforts to administer and produce more effective reference rates.
In remarks at the Annual Prime Dealer Meeting in New York, Ms. Logan explained that the uncertain future of LIBOR has caused the NY Fed and other regulatory bodies to consider alternatives and implement viable transition plans. She noted that efforts have thus far focused on interest rate derivatives, but that all LIBOR-reliant market participants must consider transition measures. Ms. Logan encouraged all firms to (i) adopt contract language capable of addressing the cessation of LIBOR, and (ii) reduce reliance on U.S. dollar LIBOR by transitioning to alternative rates.
Ms. Logan highlighted efforts to improve the effective federal funds rate (“EFFR”), develop the overnight bank funding rate (“OBFR”), and develop three new Treasury repo reference rates, and said that all of these rates are “anchored in active underlying markets” and designed to serve as reliable measures of market activity. She described various enhancements to the EFFR, explained the evolution of the OBFR, and asserted that the NY Fed will release statements detailing the compliance of NY Fed-administered and produced rates (including the planned Treasury repo rates) with the IOSCO Principles for Financial Benchmarks. Ms. Logan emphasized that the NY Fed intends to make clear what each reference rate is meant to measure in order to avoid making frequent changes to any of the reference rates. She acknowledged that certain changes may be necessary, as dictated by the evolution of underlying markets.
Ms. Logan said that the new Treasury repo rates were developed in order to improve transparency of conditions across a broad range of activity in the market. As previously covered, the following three rates will be produced:
- Secured Overnight Financing Rate (“SOFR”) will be the “broadest measure” of overnight Treasury financing transactions. The rate includes tri-party repo data from the Bank of New York Mellon (“BNYM”), as well as cleared bilateral and General Collateral Financing (“GCF”) repo data from the Depository Trust & Clearing Corporation (“DTCC”). This rate was recently chosen by the Alternative Reference Rates Committee to be used as the alternative to U.S. dollar LIBOR.
- Tri-Party General Collateral Rate will be based only on tri-party repo data from BNYM.
- Broad General Collateral Rate will be based on tri-party repo data from BNYM, as well as cleared GCF repo data from DTCC.
Ms. Logan shared four key points relevant to the calculation of the three new rates:
- they will be calculated as volume-weighted medians;
- various measures have been put in place to ensure adequate data collection for all three rates;
- trades from the FICC-cleared bilateral data set with rates below the 25th volume-weighted percentile will be excluded (or trimmed) from the SOFR calculation; and
- the NY Fed is working to determine which historical data will be most useful to help the adoption process for all rates (with an emphasis on the SOFR).
The NY Fed intends to begin publishing these three rates on a daily basis starting in the second quarter of 2018.
Lofchie Comment: Notwithstanding the efforts described to improve certain existing rates and propose new repo reference rates, the question remains: transition to what? While the regulators are quite right to point out the deficiencies of LIBOR (e.g., the absence of transaction-volume to determine a genuine rate), the path forward is still unclear as it is not obvious that the new indices, based on collateralized borrowing, can serve the purpose for which LIBOR was intended.