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New U.S. credit benchmarks gain traction as Libor deadline approaches

2021-04-26
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Even as the push for an alternative called the Secured Overnight Financing Rate (SOFR), it is expected that the new U.S. bank credit benchmarks would gain traction in the coming months as the deadline to phase out exposure to the discredited Libor approaches.

The deadline provided to investors to stop basing new loans and trades on Libor is coming to an end, where some Libor rates will not be published after Dec 31, others will end by mid-2023.

Due to concerns about the amount of derivatives using the rate, Libor is being phased out, and after it was manipulated before and during the financial crisis, in several cases is based on  assumptions about their borrowing costs and not actual trades.

The change, that is going to reduce the dependence on just one key rate, will require more than $200 trillion in trades and loans to move to new benchmarks. Even several new indexes would gain prominence.

Most of the Libor based derivatives will be migrating to SOFR, which is to replace Libor. It is based on around $1 trillion in daily loans in the U.S. overnight repurchase agreement market. Still various banks and investors would look for a rate that includes the bank credit component, and hence will look for other alternatives.

In a statement the CEO of the American Financial Exchange, Richard Sandor, stated that the shift from Libor is an opportunity that would come once in 100 years, and stated that he has never been more bullish.

Even though the move is in the early stages, Ameribor and Bloomberg’s Short-Term Bank Yield Index (BSBY) are gaining interest as benchmarks for loans. As a Libor replacement, the ICE Benchmark Administration, part of the Intercontinental Exchange, also plans to offer the U.S. Dollar ICE Bank Yield Index.

Referencing Bloomberg’s index, Bank of America stated that it has issued a $1 billion, six-month floating rate note. Standard & Poor’s and Fitch Ratings have both indicated that BSBY meets their requirements as a money market reference rate, opening the door to money fund investments in notes based on the index.

As per Daniel Krieter and Daniel Belton, analysts at BMO Capital Markets, the BSBY could become a more common benchmark rate, as it has several desirable features relative to SOFR.

After the Alternative Reference Rate Committee (ARRC), a group of market participants that selected SOFR to replace Libor, several market participants were frustrated, stating that it will not be able to recommend a forward looking SOFR rate by mid-year, its former target date.

The CME Group has since said that it will offer SOFR term rates based on its SOFR futures trading.

The New York Federal Reserve began publishing SOFR in April 2018, but the shift away from Libor has been slow.

Around $223 trillion worth of contracts now reference U.S. dollar Libor, compared with $199 trillion at the end of 2016, the ARRC said last month.

Though a portion of the market used to hedge loans is expected to reference the credit alternatives, most derivatives are expected to shift to SOFR.

In the first quarter, trading in the CME Group’s SOFR futures rose to a record 112,000 average daily contract volume, which though is well below the 2.72 million in average daily contract volumes for Eurodollar futures based on Libor.

CME has stated that the remaining shift of the eurodollar contracts based on Libor to SOFR futures will be done when the Libor rate stops being published in mid-2023.

Padhraic Garvey, regional head of research, Americas, at ING has said that he is convinced that SOFR will be the dominant rate going forward.

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