Following up on our previous post, “The LIBOR Transition — What is LIBOR and why is it important?”, from earlier this week, in this update on the transition away from LIBOR (London Interbank Offering Rate) as the reference rate of choice for financial transactions, we discuss one such alternative, the Secured Overnight Financing Rate (SOFR) issued by the Federal Reserve Bank of New York (”FRBNY”).
On November 4, 2019, the FRBNY released a statement that the FRBNY, in cooperation with the Treasury Department’s Office of Financial Research, is proposing to publish on a daily basis three compounded averages of the SOFR. The FRBNY also plans to publish a daily SOFR index to enable parties to calculate compounded average rates over time periods chosen by the parties.
The daily compounding would more accurately reflect the “time value of money than a simple average,” but would be published only on business days. Simple interest equal to the SOFR rate for the previous business day would apply to a weekend or holiday.
In addition, the three compounded averages with tenors of 30-, 90-, and 180- calendar days will mirror interest payment periods of most existing LIBOR-referencing instruments. The SOFR index would measure what the FRBNY describes as “the cumulative impact of compounding the SOFR on a unit of investment over time, with the initial value set to 1.00000000 on April 2, 2018, the first value date of the SOFR.” After that, the index would be compounded by the value of each SOFR.
Publishing compounded averages of the SOFR could greatly help adoption throughout the market. Increased use of SOFR in the loan market, could “encourage greater use of SOFR derivatives to hedge positions in these instruments.” This could ease the transition from LIBOR. More accurate hedging also may contribute to better market functioning.
The questions requested for public comment include questions regarding the method of calculation, the choice of fixed tenors, the choice of proposed decimal precision, and the proposed publication dates and times. The public comments are due December 4, 2019, and the FRBNY is planning to begin publishing these rates during the first half of 2020.
“The LIBOR Transition” is a periodic series of updates discussing reference interbank offering rates, such as LIBOR, and the challenges involved in navigating a successful transition from their use as reference rates of choice in the market. Norton Rose Fulbright has assembled a group of its lawyers from around the globe to stay on top of these issues and assist clients in the transition to new reference rates. More information can be found on our Norton Rose Fulbright web site.