The likely
But regulators still appear intent on new loans and ABS pricing over replacement benchmarks by the end of 2021, making for a busy and challenging year ahead.
The extension may be finalized soon after Jan. 25, when feedback is due on the ICE Benchmark Administration’s (IBA) Dec. 4 consultation to extend support of Libor past the original Dec. 31, 2021 cut off.
The IBA is expected to share results with regulators and the public “shortly thereafter,” according to a Dec. 7 update by the Alternative Reference Rates Committee (ARRC), a private group under the auspices of the New York Federal Reserve that has promoted the development of the Secured Overnight Financing Rate (SOFR), a USD Libor replacement.
The IBA appears to have secured support from banks to continue submitting their interbank borrowing costs and cost estimates used to generate Libor, sources said. However, the push to price new floating-rate loans and derivatives over a replacement rate in 2021 remains.
Libor, or the London Interbank Offering Rate, is being phased out by the UK’s Financial Conduct Authority because of a history of bank manipulation as well as concerns about the accuracy of interbank-borrowing-cost submissions to ICE from a panel of global banks. The FCA was originally going to stop requiring submissions after 2021, making them voluntary, and now the requirement extends to mid-2023. The submissions’ accuracy has come under fire for often relying on estimates rather than actual quotes due to increasingly infrequent interbank lending.
Tom Wipf, ARRC chairman and vice chairman of institutional securities at Morgan Stanley, said in the ARRC statement that “it is essential to continue momentum towards ending new Libor (transactions) by end-2021 and adapting robust reference rates like SOFR.”
The ARRC recommends asset-backed securities (ABS) transactions no longer price over Libor after June 30 of next year, and CLOs after Sept. 30. Early indications suggest meeting those guideposts, which do not carry the force of a regulatory rule, may be challenging. The ARRC recommends relatively straightforward floating-rate notes stop pricing over Libor by Dec. 31, 2020, but that seems unlikely.
Federal financial regulators stepped up the pressure in late November, issuing a joint statement encouraging U.S. banks to stop entering into contracts that utilize the U.S. dollar Libor index benchmark rates.
So lenders, sponsors and investors are under pressure to transition to a new benchmark next year for new-issue deals. That promises deep challenges to sponsors and investors, since the most likely replacement – a term rate based on the SOFR remains a work in progress.
“We don’t have a window on all transactions, but the ones we do know about are not moving away from Libor just yet,” said Gareth Old, a partner focusing on derivatives and structured finance at Clifford Chance.
Only a few securitizations have priced over SOFR so far. Fannie Mae issued the first-ever, SOFR-referenced
The uptake of using SOFR to price consumer and large commercial loans has been minimal, although Fannie has launched several adjustable-rate mortgage products linked to SOFR.
“The expectation behind the timeline, is that by the middle of next year, corporate treasurers and other big borrowers will be more comfortable moving to SOFR,” Old said. “At the moment, we’re not seeing a big trend toward that.”
That hesitancy may stem from the uncertainty of how to set SOFR. SOFR is a daily rate setting a benchmark interest rate for derivatives and loans, published and administered by the New York Federal Reserve.
But the NY Fed does not publish a SOFR term rate – such as one-month or 90-days – similar to the Libor benchmarks most commonly used in asset-backed securities and floating-rate collateral loans and contracts used in securitization pools.
There are currently numerous ways to calculate SOFR from its daily rate into a longer-term benchmark, which issuers are using mostly in working up ABS and collateralized loan obligation deal documents to account for an alternative benchmark replacement. The most common methods include compounding the daily pricing figures in arrears or establishing a forward rate based on pricing average.
Each produces a different result, and loans calculating SOFR in different ways within a securitization could create some risk because of volatility experienced with the rate since the NY Fed began publishing it in 2018.
“Someone has to pick the rate, so we can then figure out how to get it into our systems,” said Thomas Majewski, managing partner of Eagle Point Credit Management, noting that $20 billion of new U.S. CLO issuance came in October and November that was all Libor-based.
If securitizations and their collateral are to transition to a replacement benchmark in 2021, as regulators appear to be insisting, there may be insufficient time for the market to settle on a new benchmark such as SOFR, a secured rate calculated in multiple ways that behaves very differently from unsecured Libor.
One solution may be to develop the forward-looking term SOFR, echoing Libor’s well-understood one-, three and six-month terms that enable borrowers to understand their interest payments over specified periods.
“That’s been seen as a much more understandable solution for Main Street borrowers, such as corporate treasurers, rather than a backward-looking SOFR that completely changes the way you do your calculations,” Old said.
Such term rates, however, require sufficient SOFR-based futures and swaps to create a forward-looking interest-rate curve or face concerns about potential manipulation—similar to the woes besetting Libor.
Regulators’ skepticism about such term rates appears to be lessening “and there are more promising sounds about the development of a term SOFR,” Old said, but “I don’t think anybody is confident it will happen within the 2021 timeframe.”
Another solution for legacy securitizations developing next year may be state legislation in New York mandating the transition of their collateral to a commonly accepted version of SOFR. Most floating-rate debt contracts underwritten via New York financial markets are subject to state law, and a bill was introduced in the state senate Oct. 28 that seeks to guide market participants to a replacement benchmark selected by banking regulators or the ARRC.
But that proposal is
Similar federal legislation crafted by U.S. Rep. Brad Sherman (D-CA) has yet to be introduced.
Majewski noted that legislating a change in contractual language may be problematic. “It’s a novel idea, but it sounds a lot like taking away someone’s property rights,” he said.
