The New York Federal Reserve on Tuesday began publishing a benchmark interbank lending rate that could eventually replace the scandal-tarnished Libor.
The new Secured Overnight Financing Rate (SOFR) was set at 1.80%, marking a milestone for U.S. regulators’ effort to reduce markets’ reliance on Libor, which has also seen a decline in loans backing the rate.
“It’s going to be based on a very, very robust set of transactions. I don’t think a lot of the issues and unknown volatility around Libor is going to exist,” Blake Gwinn, an interest rate strategist at NatWest Markets, told Reuters.
Libor underpins about $200 trillion in derivatives and loans but has been tainted by widespread rigging by the banks that set it. The rate’s recent rise to its highest level since March 2008 has also fueled concerns about the robustness of Libor, which is sometimes estimated rather than based on actual transactions.
“It’s kind of got everybody scratching their heads trying to figure out why it’s doing what it’s doing,” Gwinn said.
SOFR is based on transactions in the Treasury repurchase market, where banks and investors borrow or loan Treasuries overnight. A group of large banks, the Alternative Reference Rate Committee, selected the rate in February, citing the depth and robustness of the repo market where around $800 billion is traded daily.
The New York Fed’s publication of SOFR is the first in a series of steps to enable a transition from Libor, with the CME Group scheduled to begin trading futures based on the rate on May 7. The head of Britain’s financial markets regulator said last year that a Libor substitute must be in place for banks to use by the end of 2021.
According to Reuters, a move away from Libor “is expected to be gradual and complicated,” in part because SOFR is an overnight rate only, while U.S. dollar Libor is currently published according to different terms.
The ARRC has announced that its paced transition plan includes the creation of a term reference rate based on SOFR derivatives once sufficient liquidity has been established.