The Alternative Reference Rates Committee (ARRC) was originally convened in 2014 by the Federal Reserve Board (FRB) and the New York Fed in response to recommendations set forth by the Financial Stability Board (FSB) and the Financial Stability Oversight Council (FSOC) to address risks related to USD LIBOR. The initial objective was to identify risk-free alternative reference rates for USD LIBOR.1 In 2017 the ARRC identified the Secured Overnight Financing Rate (SOFR) as the rate that represents best practice for use in certain derivatives and other financial contracts, and outlined in a Paced Transition Plan specific steps and timelines to encourage the adoption of SOFR as a LIBOR alternative.2

In 2018 the ARRC was reconstituted with an expanded membership, including banks, asset managers, financial futures exchanges and industry associations, as well as a number of working groups tasked with specific objectives, in order to effectively implement the Paced Transition Plan3

The ARRC is working in parallel with other LIBOR currency jurisdictions to reform international benchmark rates, and to the extent possible is coordinating its plans with these other global groups.4

What this means

Having identified SOFR as the rate that represents “best practice” for use as an alternative benchmark rate, the Paced Transition Plan recommends specific steps and timelines designed to encourage the adoption of SOFR.5 In order to develop sufficient liquidity, the ARRC is focused on supporting the launch and trading of SOFR-based financial products in the market, and developing a forward rate curve based on SOFR.6 In the year since the New York Fed began daily publication of SOFR, significant progress has been made in building liquidity in SOFR-linked markets, and transactions regularly exceed $800 billion in daily volumes, which while still small compared to the trillions of dollars benchmarked to LIBOR, are far larger than the transactions in any other U.S. money market.7

In addition to the Paced Transition Plan, the ARRC has noted that many contracts for products referencing LIBOR do not have robust fallback language, and do not adequately account for the possibility that LIBOR may no longer be useable.8 In response, the ARRC has published Guiding Principles for More Robust Fallback Contract Language in Cash Products, which while it is completely voluntary if any market participants adopt the suggested contract language, the ARRC in consultation with industry working groups, aims to create consistency across asset classes and products that are to be transitioned from LIBOR to SOFR. The guidelines suggest that the contract language should be consistent across asset classes and liabilities, and should seek to minimize litigation risk as well as judicial and regulatory risk for all market participants.9 It should also allow for any spread adjustments and valuation changes, together with succession timing and mechanics, which would be involved in transitioning contracts from LIBOR to SOFR.10 The ARRC also advised that market participants should align contract language in other jurisdictions in order to simplify transition and minimize value transfer and basis risk in multi-currency agreements, and to this end, the guidelines recommend that market participants should seek to use SOFR, or a benchmark based on SOFR, as a primary basis for a replacement rate where appropriate, in order to achieve consistency in transition.11

The ARRC as of April 2019 has issued final recommended contractual fallback language for Floating Rate Notes (FRNs) and syndicated loans, and is working on finalizing language for bilateral business loans and securitizations later in the year. They have also been actively engaged with the International Swaps and Derivatives Association (ISDA) to develop preferred practices for agreements and contracts in derivative products.12

Conclusion

The ARRC is serving as a forum to coordinate and track planning for the LIBOR to SOFR transition across cash and derivatives products, and now includes a broad spectrum of market participants. This broader market representation should help with the implementation of the Paced Transition Plan, and the ARRC is expected to continue to deliver recommendations for addressing risks in contract language, orderly transitions to SOFR on a voluntary basis, and actions that can facilitate such transitions.13 “In the year since SOFR’s publication, SOFR futures markets, cleared swap markets, and debt markets have been established and steadily developed. During that time, the ARRC has also taken critical steps to support a smooth transition and participation in our group has expanded,”14 said Tom Wipf, Chair of the ARRC. Adding, “While these accomplishments are laudable, the deadline for when LIBOR could become unusable is quickly approaching. It’s essential that all market participants prepare for the transition away from LIBOR now.”15

References

  1. The Alternative Reference Rates Committee website, About section. Access at: https://www.newyorkfed.org/arrc/about.
  2. Ibid
  3. Ibid
  4. Ibid
  5. The Alternative Reference Rates Committee website, Transition from LIBOR section. Access at: https://www.newyorkfed.org/arrc/sofr-transition.
  6. Ibid
  7. The Alternative Reference Rates Committee website, Transition from LIBOR section. Access at: https://www.newyorkfed.org/arrc/sofr-transition. “SOFR: A Year in Review,” Alternative Reference Rates Committee, April 2019. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/SOFR_Anniversary.pdf.
  8. “SOFR: A Year in Review,” Alternative Reference Rates Committee, April 2019. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/SOFR_Anniversary.pdf.
  9. Ibid
  10. “ARRC Guiding Principles for More Robust LIBOR Fallback Contract Language in Cash Products,” Alternative Reference Rates Committee. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2018/ARRC-principles-July2018.
  11. Ibid
  12. “SOFR: A Year in Review,” Alternative Reference Rates Committee, April 2019. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/SOFR_Anniversary.pdf.
  13. “Keeping Up With the ARRC,” Securities Industry and Financial Markets Association, January 30, 2019. Access at: https://www.sifma.org/resources/news/keeping-up-with-the-arrc/.
  14. “ARRC Document Highlights SOFR’s Progress to Date,” Alternative Reference Rates Committee, April 29, 2019. Access at: https://www.newyorkfed.org/medialibrary/Microsites/arrc/files/2019/ARRC-Apr-29-2019-announcement.pdf.
  15. Ibid

Newsletter Author: Venetia Woo, Mairi Bryan, Anwar Ali

Newsletter Contact Person: Venetia Woo

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