Illustration: Sarah Grillo/Axios
The lending world's slow move away from the Libor benchmark interest rate has been going on for more than a decade. But things are finally speeding up — with some investment banks planning to arrange new loans based on alternative benchmarks as soon as July, multiple sources tell Axios.
Why it matters: Banking regulators have been trying to phase out Libor since a 2008 rate-manipulation scandal, but it is still widely used in the U.S. The long transition has given rise to multiple replacement options, leaving borrowers and investors in limbo when making certain investment decisions.
Context: More than $200 trillion in global debt is currently Libor-based.
What’s new: “We're aware of one bulge bracket bank that has indicated an intention to stop offering their borrowers new Libor-based instruments after June 30 of this year,” Matt Hoffman, director at financial risk advisor Chatham Financial, tells Axios.
Of note: The bank in question said it prefers to move to BSBY (Bloomberg Short-term Bank Yield Index) as an alternative, but is willing to quote over SOFR (Secured Overnight Funding Rate), Hoffman says.
- “We've heard from others active in our space that more banks are considering doing the same, and that we can expect to know more in coming weeks,” Hoffman adds.
Background: The Federal Reserve created the Alternative Reference Rate Committee (ARRC) in 2014 to shepherd the Libor transition. ARRC initially threw its heft behind SOFR, effectively an overnight risk-free rate.
- But market participants have called for a forward-looking term — rather than overnight — benchmark. With a term rate, a borrower knows its debt service costs in advance, and can plan accordingly. It’s less volatile, and less complicated.
- The market has also asked for a credit-sensitive — rather than risk-free — benchmark. The risk-free SOFR is backed by Treasuries, so banks that lend using SOFR could find themselves in an asset-to-liability mismatch in times of market stress. This could lead to a greater need for rate hedging.
ARRC on May 21 said it would, finally, “soon” make a formal recommendation that a Term SOFR be used in lending, administered by derivatives exchange CME Group.
Yes, but: In the meantime, other term and credit-sensitive alternatives have gained steam, including BSBY and Ameribor.
The big picture: Choice can be good. But a multi-benchmark environment would mean borrowers have to weigh a host of pros and cons each time they borrow – potentially without a perfect solution for all cases, Hoffman says.
- For lenders, questions arise around liquidity and pricing, as well as balancing asset to liability management.
What to watch: The Fed has asked that loans issued after December 31 not be tied to Libor. By June 2023, all legacy Libor contracts must transition.