On April 17 the Alternative Reference Rate Committee (ARRC) published a set of key objectives for 2020 to support the transition from USD LIBOR to SOFR as a more robust and resilient alternative. They consist of a mixture of milestones, with a target date for completion, and more generic goals that it expects to be ongoing.
Although the objectives and one would assume the milestones, in particular, were developed with the potential impact of COVID-19 in mind, I think it is very important to note that the ARRC specifically referred to the statement from the FCA on the 25th of March in which it confirmed that the central assumption that LIBOR cannot be relied on after 2021, has not changed.
The financial industry has gotten used to regulations being delayed by months or years if the regulators could be convinced the industry was not ready and COVID-19 was “used” to delay a number of regulatory deadlines in the past weeks already. We think that will not be the case for LIBOR transition and any potential delays are likely to be measured in weeks, not months or years.
The industry has had plenty of warning of the 2021 deadline. It should also be remembered that, although many people seem to think so, the transition of loans, derivatives, and a myriad of other products, away from LIBOR is not a regulatory change. Whilst the FCA and other regulators help drive the transition, they do so because this is such a fundamental change with associated risks to the firms they regulate, consumers, and the wider financial system. But the ultimate driver is the risk of LIBOR not being a representative interest rate.
In fact, the FCA has a regulatory duty to determine whether or not published LIBOR rates, which underpin trillions of dollars of contracts, are in fact representative. A lack of underlying transactions and methodology that is at odds with benchmark principles have been defined as fundamental problems. COVID-19 is not going to change that. As my colleague Tom Hicks only wrote last week, we believe it is very much a case of “Keep Calm and Transition On”. ARRC’s 2020 objectives and milestones are grouped in line with six core objectives of the Committee:
1. Supporting SOFR use and liquidity. Specifically:
a. Establish an RFP process and select an administrator of a forward-looking term SOFR rate, to be published in the first half of 2021, and recommend the scope of such a term rate. Date: by 30th of September.
b. Provide final recommended SOFR conventions for FRNs, loans and securitizations Date: 31st of July
c. Work with market participants to facilitate the use of SOFR PAI and discounting for USD interest rate derivatives. Date: Ongoing but the clearinghouses currently have this scheduled for October.
2. Market infrastructure and operations. The ARRC provides few specifics on this topic.
3. Contractual fallbacks. Specifically:
a. Establish an RFP process and select an administrator to publish the recommended spread adjustments and finalize technical details on spread adjustments. Date: by 30th of September
b. Publish revisions to the ARRC’s hardwired fallback language, conventions and supporting materials for business loans. Date: by 30th of June
4. Consumer products. Specifically:
a. Publish fallback language for new student loans referencing LIBOR and conventions for new student loans referencing SOFR. Do the same for other consumer products if appropriate. Date: by 30th of June.
b. Develop resource guides identifying recommended actions to support efforts to develop programs for consumer education and outreach. Date: by 30th of September
5. Legal, tax, accounting and regulatory clarity. Specifically:
a. Continue to pursue potential legislative relief for so-called ‘tough-legacy’ contracts.
b. Continue to work with tax, regulatory and self-regulatory organisations as they finalize proposals for tax, regulatory and accounting measures to address LIBOR transition.
6. Outreach, education and global coordination.
The last two points are quite generic goals for the ARRC and/or are dependent on input and timing from other organisations. As a result, these are typified as ‘Ongoing’ and have no target dates set. The fourth objective of consumer products is of course quite specific for the US and we will not go into detail here. Suffice to state that even for this potential minefield some clear deadlines are set by the ARRC.
As a result, ARRC’s focus of most interest to our typical clients is still around conventions for spread adjustments and fallback language, operational readiness, and the use of SOFR for discounting of interest rate derivatives. So perhaps not much change there. But we note the set deadlines by ARRC above (June and September) and the PAI switch to SOFR by the clearinghouses currently scheduled for October. With the very recent news that the similar switch to ESTR for EUR-denominated products was only delayed by five weeks, despite being announced near the apex of the COVID-19 pandemic in Europe, we expect little delay to any of these objectives and expect that the industry should be ready to seriously start transitioning to SOFR before the end of the year.
By Chris Heeringa, Partner Dantum Consulting