The case for industrywide use of SOFR
A recent op-ed in American Banker criticizing an alternative rate index used in loan contracts, and our group that supports the index, has prompted a need to respond.
While the author is certainly entitled to his views, it is important they are premised upon actual, underlying facts. In the case of this op-ed that specifically calls out the Alternative Reference Rates Committee, we felt it was important to clarify those facts.
First, any debate about reference-rate transition in the United States — part of a Herculean global financial effort — should represent the history and evolution of that transition accurately. The ARRC is a group of private-market participants convened by the Federal Reserve to help ensure a successful transition in the U.S. for those using the London interbank offered rate (Libor) to a more robust reference rate.
As such, the ARRC has been both transparent and inclusive. The ARRC's membership is made up of a broad set of private-market participants — including banks, asset managers, insurers and industry trade organizations — and official sector ex-officio members.
A minority of the ARRC membership are banks or associated with banks. This membership allows the group to have diverse participation across financial services. Participation in the ARRC has grown considerably since its inception in 2014. There are now more than 300 member and nonmember institutions committed to a stable transition.
After more than two years of transparent research and public consultation, the ARRC selected its preferred alternative: the Secured Overnight Financing Rate. The SOFR was identified as the most suitable alternative rate for institutions of all sizes, whether they are viewed as large, medium or small enterprises.
The SOFR is based roughly $1 trillion of daily transactions from a wide range of market participants and is administered by the New York Fed. Based on daily repo market transactions, SOFR is, by intent and construction, a reliable and representative indicator of market interest rates.
As such, the underlying transaction volume for SOFR has remained consistent, even during the recent pandemic-related market turbulence. However, the op-ed also left out the fact that variability in SOFR’s daily print should not be an issue, since SOFR is averaged when used in financial contracts.
Indeed, a three-month average of overnight Treasury repo rates has historically been less volatile than three-month U.S. dollar Libor over a wide range of market conditions.
Finally, the op-ed’s portrayal of our proposed legislation to New York State lawmakers is false. Many existing contracts either lack any provisions that deal with Libor’s end or have provisions that would cause significant, unintended economic impacts.
This legislation intends to address the legal uncertainty and economic harm that Libor’s end would otherwise create for consumers, businesses, lenders and investors. The op-ed’s safe harbor claim is misleading. The proposed legislation only substitutes SOFR if a contract would otherwise provide no backup or defaults to a Libor-based rate. And the proposal has no safe harbor provision for most legacy business loans, which typically revert to another floating rate.
Even then, parties can always agree to take a different approach — so the legislation in no way limits banks’ freedom to do something different.
The SOFR is a transparent and reliable rate. We hope the public dialogue around this transition is equally transparent and fact based.
Charles Schwartz is co-chair of the outreach and communications working group of the Alternative Reference Rates Committee, or ARRC.