SOFR activity is spreading across the curve. The FOMC has updated this "Fed Dot Plot" quarterly since January 2012. SOFR is based on repo trades. In addition, on July 29, 2021, the ARRC formally recommended the CME Group's forward looking 1-month, . For more information, contact mcoffey@lsta.org, tvirmani@lsta.org or ehefferan@lsta.org. The rate is published by the New York Federal Reserve to serve as a rate upon which other debt transactions can . SOFR measures of the cost of borrowing cash overnight collateralized by Treasury securities. This ongoing Liberty Street Economics series analyzes disparities in economic and policy outcomes by race, gender, age, region, income, and other factors. From an administrative standpoint, the main difference will be the reference to SOFR instead of USD LIBOR and the application of the Spread Adjustment to obtain a SOFR equivalent of an existing LIBOR margin. The ARRC Business Loans Working Group (BLWG), which is co-chaired by the LSTA, developed these conventions. SOFR is a reference rate (benchmark rate) and an alternative to the US Dollar LIBOR rate. %PDF-1.6 % Below, we focus on Term SOFR and flag where the conventions are similar to LIBOR, and where they may differ slightly. Many financial contracts have used overnight rates, but typically use an. Charlotte, NC 28203. Compounded SOFR in advance and Term SOFR tend to be the two most commonly used indices. Simple average SOFR is calculated in arrears meaning it reflects the Overnight SOFR resets during the actual accrual period. A breakage cost occurs if the borrower prepays (1) for Daily Simple SOFR, on a day other than a payment date or (2) for Term SOFR, on a day that is earlier than the last day of the interest period. If only focused on a loan portfolio, Term SOFR will (likely) always be lower, but that is why the SOFR Adjustment is there. The Center for Microeconomic Data offers wide-ranging data and analysis on the finances and economic expectations of U.S. households. In theory, transitioning from the use of LIBOR to SOFR in contracts should be simple: The old rate wasn't based on real transactions and was subject to manipulation, so we'll use the new rate that is based on real transactions and therefore can't be easily manipulated. I am not sure non-term rates will have much use in the loan market, today. SOFR benefits from the ARRCs support and the CFTCs SOFR First best practices, which should promote the growth on a SOFR swaps market. The New York Fed offers the Central Banking Seminar and several specialized courses for central bankers and financial supervisors. The risk-free nature of SOFR brings challenges that have caused many banks to advocate for credit-sensitive benchmark rates developed in the private market. What Is a REMIC and How Does It Play Into My Defeasance? Compounded SOFR in arrears and Daily Simple SOFR may still be used by borrowers and lenders if they choose. 3 2. Based on these and other criteria, the ARRC identified SOFR, where disinterested third-party clearinghouses report the terms of the large volume of transactions underlying the rate, as compared with determining LIBOR, which, as a practical matter, is based on panel banks submitting borrowing costs based on expert judgment because there is so little unsecured bank-to-bank lending post-Great Financial Crisis. 3 777 0 obj <>stream For that reason, its often referred to as overnight SOFR. What then for new or existing LIBOR loans that mature after the end of 2021 . The smoothing effect is more evident as we increase the reference interest period. Not all end-users make widgets. The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. Permit movement from daily SOFR to term SOFR - It is possible that term SOFR (the first level of the waterfall) will not exist at the time a SOFR-priced loan agreement is entered into, and the loans will thus be priced at a rate based on daily SOFR (the second level of the waterfall). This was one of the arguments against using Compounded SOFR reset in advance for loans. . SOFR is more technically Overnight SOFR (today, 0.05%) Term SOFR aka CME Term SOFR is a forward-looking rate based on SOFR futures (today, 0.27%) Overnight SOFR is a retroactive rate, which means it tends to move after a Fed hike. Our economists engage in scholarly research and policy-oriented analysis on a wide range of important issues. Since LIBOR is an unsecured lending rate and SOFR is a secured overnight rate, LIBOR has historically been higher than SOFR, so a spread adjustment is necessary to make SOFR more comparable. This material is not a research report prepared by Chatham Hedging Advisors. The overnight financing part of its name references how SOFR sets rates for. Overnight rate, term not available. Yes. Units: Percent, Not Seasonally Adjusted Frequency: Daily Notes: As an extension of the Secured Overnight Financing Rate (SOFR), the 30-day SOFR Average is the compounded average of the SOFR over a rolling 30-day period. Chathams experts answer the most pressing questions asked by our clients about how the transition will affect their port. 0 The hedge/loan accrues interest daily based on SOFR and the total amount due is known at the end of the period. This release coincided not coincidentally with the publication of Term SOFR Use Cases, which included business loans, related hedges and CLOs. In order to provide the counterparties sufficient time to pay interest at the end of the period, several potential conventions are feasible (and are illustrated on p. 12 of . The webinar, This is the form used by administrative agents when a lender joins the syndicate and must provide the agent with its contact details, wiring instructions,. Even if Term SOFR Swaps have a mismatch risk, and this risk impacts pricing, it could be the case that the pricing impact is minimal due to SOFR-liquidity already creating tighter spreads and lower pricing. A forward looking term SOFR may be constructed based on SOFR derivatives markets once those markets have developed enough liquidity. But since the hike hasnt occurred yet, Compounded SOFR is still hanging out around 0.05% and will take some time to catch up once Overnight SOFR moves. The SOFR Index measures 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. In contrast, both "compound the rate" methodologies apply a calculated rate of daily compounded interest to principal and are highly conventions dependent. endstream endobj 2618 0 obj <>stream BSBY should not have the mismatch risk i.e., the Floating Rate in the Borrowers swap and the dealer-market swap can be the exact same. CME Term SOFR Reference Rates Benchmarks The CME Term SOFR Reference Rates benchmark is a daily set of forward looking interest rate estimates, calculated and published for 1-month, 3-month, 6-month and 12-month tenors. The Exposure Drafts are single currency facility agreements based on the compounded average of the RFR calculated on an in arrear basis over an observation period starting before the start of, and ending before the end of, an interest period. For example, term SOFR is a period-specific forward-looking term rate that is published for periods of 1, 3, 6 or 12 months. April 23, 2019 - On April 22nd, the Alternative Reference Rates Committee (ARRC) released A Users Guide to SOFR, which discusses the likely end of LIBOR, what it means for cash products, and how cash product consumers (such as syndicated lenders or borrowers) might think about the different variants of SOFR. (Term SOFR being step 1 in the replacement rate waterfall) upon a certain number of publicly available USD-denominated syndicated credit agreements being originated with, or switching over to, a SOFR-based rate. As part of our core mission, we supervise and regulate financial institutions in the Second District. The Economic Inequality & Equitable Growth hub is a collection of research, analysis and convenings to help better understand economic inequality. Learn how to submit it. Given how similar the terminology and rates are, it can be tricky to determine which index is being discussed, but at the end of the day they all shake out to be about the same. The interest owed each day is calculated by applying the daily rate to both the principal borrowed and the accrued, unpaid interest. We help keep our clients up to date in these fast-moving areas and to serve as a thought leader. The New York Fed has been working with tri-party repo market participants to make changes to improve the resiliency of the market to financial stress. The intention is for Term SOFR, a rate to be available during the first half of 2021, if there is sufficient liquidity, to be a USD LIBOR replacement. %%EOF Chief among them is the opportunity to participate in the decision making process that ultimately establishes loan market standards, develops market practices, and influences the markets direction. hbbd```b``@$XD2} 9D Term SOFR > Daily Simple SOFR should be the case, since Term SOFR should more closely align with SOFR Compounded In-Arrears. However, the use case for Term SOFR in the derivatives market is (deliberately) very narrow. Also, noted further below, maybe Dealers will not hedge a BSBY swap differently than a Term SOFR i.e., both Borrower swaps are priced based on the Fixed Rate in the Dealer-to-Dealer SOFR Market? This index is desirable since it would be set in advance like LIBOR, so the payment is known at the beginning of the period, and is credit sensitive which eliminates the need for an additional spread adjustment. In other words, it can be used to calculate the compounded average of SOFR over a 28 or 31 day period, whereas SOFR Average would always be 30 days. If Jay Pow continues to make the Feds printers go brrrrr, he and future Feds will keep SOFR low. Term SOFR, USD LIBOR, and Treasury Forward Curves The Secured Overnight Financing Rate (SOFR) forward curve represents the implied forward rate based on SOFR futures contracts. This week we cover SOFR Switch Accelerates; You've Got Custody! 1.64 %. March 2, 2023 - The FT recently commented that, as LIBOR deadline looms, leveraged borrowers and lenders are scrapping over the fine print as the, The SECs proposed Safeguarding Rule includes sweeping and transformative revisions to the current Custody Rule. And thats (mostly) it for the Term SOFR conventions! There are various SOFR rates/calculation methodologies which often leads to confusion. This is because Term SOFR is a risk-free rate in comparison to LIBOR which inherently includes the credit risk of the lender along with the duration risk. When a CMBS loan is originated, its common to then securitize that loan, which is the conversion A slightly irreverent take on interest rate markets and the economy. The following conventions relate to using SOFR in arrears (Daily Simple SOFR and SOFR Compounded in Arrears) for business loans. The Center for Microeconomic Data offers wide-ranging data and analysis on the finances and economic expectations of U.S. households. The more recent margin rules for swaps have expanded out what buyside entities believe themselves to be eligible for treatment as an end-user. hb```&f AXXc #i `Qkp``# U(-8]q_CMq%2f)sHXkUCf *NKse|`Pb1aCD]+:9U^^*U&8R4{:i^u"=/JdO;bmbZUz]UzAyZM]w y7%s=sMbXW|#a};5:0g^gN3;{M,y:i&I&X/c]tc2wP'c^'M,z:iTu6M}%n6```pb`:Ph` , R^PL1*mM)WkRHIv4j$LDPvFXJ3;/0\al[$0)({IiLUF%Uw7BwW3H2pX@]vBT1: !p On July 21, the ARRC released recommended conventions for forward looking Term SOFR (and SOFR Averages in Advance) for syndicated and bilateral business loans. %PDF-1.6 % As such, several possibilities for using SOFR for term lending have emerged, with the main recommendation being Daily Simple SOFR plus a spread adjustment. ), it is an overnight, fully secured rate. By using this site, you agree to our updated Privacy Policy and our Terms of Use. In effect, the term rate reflects market expectation as to what will happen to interest rates, while the compound average reflects what actually happens to interest rates over the period. About 40% of total SOFR risk is traded in . In the DVP repo market, asset managers and other investors (e.g., REITs) borrow specific securities from broker-dealers and securities lenders on a bilateral or cleared basis. LIBOR vs. SOFR. 2. and SOFR Averages. %PDF-1.6 % 3 Term SOFR is a proactive rate, meaning it moves in anticipation of a Fed hike. It is not only sub-2Y activity. For more information on the production of the SOFR Averages and Indexincluding the calculation methodology, treatment of non-business days, and value datesplease read the . 1-month LIBOR vs 1-month compounded SOFR. New York Fed SOFR Data. Check out our white paper here for more on how the transition will change your rate. Note, there will likely be minor differences due to rounding. This approach is consistent with market feedback and also the development of the SONIA- and SOFR . February March April May June July 2.2 2.4 2.6 2.8 3.0 3.2 %. The SOFR includes all trades in the Broad General Collateral Rate plus bilateral Treasury repurchase agreement (repo) transactions cleared through the Delivery-versus-Payment (DVP) service offered by the Fixed Income Clearing Corporation (FICC), which is filtered to remove a portion of transactions considered specials. The New York Fed works to protect consumers as well as provides information and resources on how to avoid and report specific scams. However, it is still uncertain what liquidity will look like in the Dealer-to-Dealer Market, which impacts pricing. If Small Banks are not qualifying as end-users, then I would expect them to prefer BSBY. 226 0 obj <> endobj This ongoing Liberty Street Economics series analyzes disparities in economic and policy outcomes by race, gender, age, region, income, and other factors. What Is SOFR? %%EOF Compounded SOFR in arrears and Daily Simple SOFR may still be used by borrowers and lenders if they choose. If the notional is constant, the total interest accrued would be the same as applying the simple average of the SOFR resets at the end of the period. There will be a mismatch here. 1300 South Mint Street, Suite #410 In July 2017, the UK Financial Conduct Authority (FCA) announced that it would no longer require banks to submit cost of funds quotes in support of calculating LIBOR, calling into question LIBORs viability and availability. Because the Term SOFR is known in advance of the interest period, it is largely documented and operationalized like LIBOR. The New York Federal Reserve Bank now publishes SOFR daily, as well as SOFR Averages and a SOFR Index. Similarly, the recommendation is to use Modified Following Business Day conventions for Term SOFR, just like LIBOR. This week we cover SOFR Switch Accelerates; You've Got Custody! Think LIBOR. H`RDH`0,"Ad:d,y$T ?/ 64 Term SOFR, BSBY or one of the other SOFR rates? to international institutions. Given the loan market's preference for a forward-looking term rate, Coffey suggested that the choice for business loans may be Term SOFR or one of the newly launched credit sensitive rates featuring a forward-looking term structure, such as the Bloomberg Short Term Bank Yield Index (BSBY). With talk of various credit-sensitive alternatives to USD LIBOR still common, weve prepared an overview of some of the leading credit-sensitive alternative benchmarks (e.g., BSBY, AMERIBOR, et al.). The NY Fed publishes SOFR Averages here and 30D SOFR can be found on Bloomberg under ticker . Lenders may want to start to compare how BSBY vs Adjusted Term SOFR Rate compare. The GCF repo market is a tri-party repo market used only between dealers who borrow cash against general collateral (i.e., securities that are not specified until the end of the trading day). With multiple SOFR indices available for use, in addition to rates such as Bloombergs BSBY (read more about BSBY here), borrowers may find themselves with a term sheet listing an index theyve unfamiliar with. In lieu of the rate being determined two business days prior to the beginning of the interest period, it will be known two business days prior to the end of the period. Alternatively, if the Borrower has no issues with managing the payment requirements of Daily Simple SOFR, then they may prefer this rate today. Term SOFR is eligible for use in general business loans (in contrast to the much narrower use cases for Term SONIA or any STR1 -based forward-looking term rate). Heres an example comparing SOFR Index and SOFR Average: [(1.04136820% / 1.04085026%) 1] * (360/30) = 0.59713% which matches the 4/1/2020 30D SOFR Average print. SOFR can be seen as the average interest rate for secured loans issued in American Dollars (USD) with a maturity of 1 day (overnight). The above issue is really much broader. SOFR interest rate. Since the rate is calculated in arrears, the reset for that accrual period won't be known until approximately 1 month after the reset date for the period in question. For right now, maybe it is best to not put all your eggs into one basket. Simple interest is calculated by applying the daily rate to the principal borrowed, and the payment due at the end is the sum of those amounts. SOFR is typically published on US business days, and CME Term SOFR aligns with that calendar. Chief among them is the opportunity to participate in the decision making process that ultimately establishes loan market standards, develops market practices, and influences the markets direction. This mismatch may increase the costs (i.e., increase the Fixed Rate) on a Term SOFR Swap, so that the Lender can capture some profit that will be used to cover risks associated with this mismatch. Do you have a Freedom of Information request? Need to file a report with the New York Fed? I am assuming that most Borrowers will be less focused on the nature of the floating rate, and more focused on the cost of any hedge. White Collar, Regulatory Defense, and Investigations, Jay Pow continues to make the Feds printers go brrrrr, Data Points: Privacy & Data Security Blog, MVA White Collar Defense, Investigations, and Regulatory Advice Blog. SOFR Loan Product Challenges Using an overnight rate in a market accustomed to Home / News & Resources / News / Understanding SOFR. SOFR is also manipulated by the Federal Reserve, so in times of stress the Fed can force this rate to drop and keep the rate there. Use of the Reference Rates are subject to important disclaimers, limitations and indemnification obligations. Term SOFR > Daily Simple SOFR should be the case, since Term SOFR should more closely align with SOFR Compounded In-Arrears. For more resources or help, check out Pensford.com/SOFR or give us a shout. There are several different types of SOFR: (1) Daily Simple SOFR, (2) Daily Compounded SOFR, (3) Term SOFR, (4) SOFR Averages, and (5) SOFR Index. It seems like many people other than me were also very critical of Genslers comments as being misleading/inaccurate. SOFR activity is increasing in terms of risk traded. ET. Our primary objective is to maintain a safe and competitive U.S. and global banking system. 751 0 obj <> endobj As I have mentioned in the past, I would expect the rate most commonly used by Lenders will be the floating rate that can be swapped out for the lowest fixed rate. SOFR is based on the U.S. Treasury Repo (repurchase) market which is a deep and liquid market with over $900 billion1 in average daily . hbbd``b`y H0[lA7@B6H\u}_ > hbbd``b`$g! Since ISDA SOFR is meant to serve as a replacement for LIBOR, the difference between the two rates is minimal. In the Dealer-to-Dealer Market, SOFR may have greater liquidity and are clearable. Think Prime or Fed Funds. SOFR activity is demonstrably different to Fed Funds activity. For that reason, we put together a resource last year titled The Different SOFR Rates which includes a flowchart illustrating how the various rates relate. Periodic Term SOFR Determination Day has the meaning specified in the definition of "Term SOFR". All rights reserved. The Federal Reserve Bank of New York works to promote sound and well-functioning financial systems and markets through its provision of industry and payment services, advancement of infrastructure reform in key markets and training and educational support In contrast, because Term SOFR is known in advance of the interest period just like LIBOR today the Term SOFR loan conventions are very similar to LIBOR loan conventions. Therefore, over a period of a few years wed anticipate the difference to average out such that a borrower is largely indifferent between one index and another. The mission of the Applied Macroeconomics and Econometrics Center (AMEC) is to provide intellectual leadership in the central banking community in the fields of macro and applied econometrics. SOFR is now being used across the US structured finance market, a credit . Term SOFR is a proactive rate, meaning it moves in anticipation of a Fed hike. Because both Daily Simple SOFR and this compounding approach apply the daily SOFR rate (the former to principal and the latter to the balance) they are mechanically similar. The creation of a forward-looking term SOFR index based on derivatives markets was the final step in the ARRCs Paced Transition Plan. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. This is a compounded average of SOFR over the accrual period. With the different forms of SOFR rates in place i.e. The CME Term SOFR Reference Rates benchmark is a daily set of forward-looking interest rate estimates, calculated and published for 1-month, 3-month, 6-month and 12-month tenors. Alternatively, if we ever do see rates rise, then BSBY may be higher than an Adjusted SOFR agreed to during a low interest rate environment. Here are all of the forms, instructions and other information related to regulatory and statistical reporting in one spot. ET. Launch of ESG Integrated Disclosure Project, LSTA/Refinitiv Mark-to-Market Pricing Data, Morningstar LSTA Leveraged Loan Index Analysis, Implementing the LIBOR Act: Federal Reserves Final Rule Podcast, LSTAs Sustainability Linked Loan Drafting Reference Documents Podcast, Register for The Corporate Lawyers Guide to Credit Agreements, The SECs Safeguarding Rule: Custody and Surprise Examinations (or Worse) for Loan Funds, Recent Sustainable Lending Updates Part 1, Updated LSTA Forms of Credit Agreement; Concept Documents, 2023 LSTA and LMA Joint London Conference, Cybersecurity, Privacy and Data Protection, Corporate Practice of Medicine Financings, Morningstar LSTA Leveraged Loan 100 Index Stats, Monthly Secondary Market Performance Charts (Feb 2023), The SECs Safeguarding Rule: Custody and Surprise Examinations (or Worse) for Loan Funds, Sustainability Linked Loans: Unpacking Sustainability Linked Loans, ESG Considerations and Avoiding ESG-washing Presentation, LSTA Requests Deadline Extension for Comments on the Conflicts of Interest in Securitizations Rule, Administrative Details Form (ADF) (Mar 2 2023), Morningstar LSTA Leveraged Loan Index Analysis (Feb 2023).