The Future is Coming (Wonkish, but Short): LIBOR Alternative

The London Inter-Bank Offered Rate is an important benchmark for trillions of dollars of contracts.  The problem is that it was rigged. The Secured Overnight Financing Rate may be an interesting alternative.

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By Marc Chandler

(this post originally appeared on Marc to Market)

Since the Great Financial Crisis, officials in the US and Europe have been moving to find an alternative to LIBOR.  The London Inter-Bank Offered Rate is an important benchmark for trillions of dollars of contracts.  The problem is that it was rigged. Some argue that there may be a better and more representative rate.

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Although the Trump Administration has sought to overturn much of the previous administration’s initiatives, going forward with an alternative to LIBOR is an area of continuity.  The Federal Reserve and the Treasury Department have worked together. At the end of 2016, the NY Fed indicated that it was considering publishing on a regular basis three different repo rates that were for transactions where US Treasury securities are used for collateral.

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At the end of last year, after receiving feedback from interested parties, the Federal Reserve indicated it was going forward with its plans.  It announced this week it would begin publishing the rates in early April around 8:00 am ET.   Investors may want to familiarize themselves with these rates:  The first and most important is the Secured Overnight Financing Rate (SOFR).  It is the rate that the relevant authorities (Alternative Reference Rate Committee) see as the recommended alternative to LIBOR.  The other reference rates are the Broad General Collateral Rates (BGCR) and the Tri-Party General Collateral Rate (TGCR).

In addition to providing a daily reference rate, the Fed will also summarize the distribution of volumes each day, and present the total dollar amount of transactions used to calculate each rate (rounded, the Fed says, to the nearest billion).   The Federal Reserve assures investors that it has adopted the policies and practices that have been identified to ensure the integrity of these reference rates.

Other countries are also working to address the weakness of LIBOR.  Some want to strengthen and protect LIBOR.  Others are more inclined to follow the Federal Reserve and adopt a different reference rate. Separate from this in the US is whether there is a better rate than the federal funds rate on which the central bank can anchor monetary policy.  The federal funds market, as other observers have noted, is not particularly deep or liquid or representative of money market conditions.  Here too the SOFR may be an interesting alternative candidate, it would seem.

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