September 7, 2017 - The multi-year march toward a LIBOR fallback/replacement for derivatives (and possibly loans) has taken another step. On August 27, 2017, the Federal Reserve issued a “Request for Information Relating to Production of Rates”. Behind this unprepossessing title is a call for public feedback on what might become the LIBOR replacement for derivatives. (Any loan fallback would almost definitely require adjustments.) We discuss the background, the Fed’s request and possible LSTA action below.

First, as the LSTA has noted – most recently in this August 24, 2017 web post – the Alternative Reference Rates Committee (“ARRC”) has been working to develop a fallback and possible replacement for LIBOR for the $140 trillion of derivatives that reference LIBOR. In the coming months and years, this effort may extend to other markets, including the $4.3 trillion syndicated loan market.

In June, the ARRC announced its recommended alternative rate, the Broad Treasuries Financing Rate (“BTFR”). However, as the pronunciation of “BTFR” apparently is unsavory, the acronym is being replaced with “SOFR” (Secured Overnight Funding Rate). But it’s the same thing – a secured overnight Treasuries repo rate.

One issue, though, is that SOFR doesn’t actually exist yet. The Federal Reserve Bank of New York (“FRBNY”) is planning to collect and tabulate the information that it will use to publish SOFR starting mid-2018 – and this is why the Fed issued a request for information.

In its request, the Fed first described the various Treasury repo markets, which will be the basis of SOFR.  A repo, of course, is the sale of a security combined with an agreement to repurchase the security at a prearranged price on a specified future date. The discount on the repo is equivalent to an interest rate.

Types of treasury repos include tri-party repo, where a clearing bank (BNY Mellon and JPM, currently) stands in the middle between a securities buyer (lender) and a securities seller (borrower). There also are General Collateral Financing (“GCF”) repos, which are completed on an anonymous basis through interdealer brokers and settle on the clearing banks’ tri-party repo platforms.  For GCF, the Fixed Income Clearing Corporation (“FICC”) acts as a central counterparty. In addition, there is a bilateral repo market where counterparties instruct their custodians to exchange cash and securities without a third party managing collateral and facilitating centralized settlement. Some bilateral repos are cleared through FICC’s DVP service, while others are non-cleared. The FRBNY currently collects data on tri-party repo, and has entered into an agreement with DTCC to collect data on GCF Repo and FICC-cleared Treasury bilateral repos.

Once it has collected and analyzed the three repo datasets described above, the FRBNY will begin publishing three rates: i) the Tri-Party General Collateral Rate (“TGCR”), ii) the Broad General Collateral Rate (“BGCR”), which is TGCR plus the GCF repo data, and iii) SOFR. SOFR will be the broadest measurement of rates, including tri-party repo information from BNY Mellon, GCF repo from DTCC, and FICC-cleared bilateral repo. In the accompanying press release, Fed Governor Jerome Powell noted, “SOFR will be derived from the deepest, most resilient funding market in the United States. As such, it represents a robust rate that will support U.S. financial stability.” (This quote indirectly speaks to why ARRC is focused on a replacement: LIBOR is thinly traded, is not deep, and is not seen as robust or resilient.)

In its request for information, the Fed asked a number of questions about whether the rates (and which ones) would be useful, how the rates (or calculation methodologies) might be changed, whether there are other sources of data that should be used, whether the proposed publication time works and whether there are other summary statistics that would be useful. The LSTA anticipates that it will respond to the request for information, with the focus on ensuring that the rates and process are as effective for the loan market as possible. For more information, please contact mcoffey@lsta.org or tvirmani@lsta.org.