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The London interbank offered rate, or LIBOR, has been called the world’s most important number. Quoted daily across five currencies and seven maturities, the rate underpins hundreds of trillions of dollars in contracts around the world from home mortgage loans to complex derivatives. For U.S. dollar (USD) LIBOR alone, the estimated exposure is approximately $200 trillion. 

The Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation have issued supervisory guidance  encouraging banks to “cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021,” noting that new USD LIBOR issuance after 2021 would create safety and soundness risks.

CREFC serves as a member of the Alternative Reference Rates Committee (ARRC), a group of private-market participants convened by the Federal Reserve Board and Federal Reserve Bank of New York. In addition, CREFC co-chairs the ARRC’s Securitizations Working Group (SWG) with the Structured Finance Association (SFA). We are focused on helping the CRE finance industry learn about the transition from LIBOR and serving as a platform to create a constructive dialogue on the challenges our industry faces during this critical period of change. 
 
For any questions or if you would like to be involved in a CREFC working group on the LIBOR transition, please feel free to reach out to Raj AidasaniLisa Pendergast or Sairah Burki.

Latest News

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LIBOR Update – IOSCO Voices Concern Over Widespread Use of Credit Sensitive Rates

September 13, 2021

On September 8, the board of the International Organisation of Securities Commissions (IOSCO) issued a statement  urging caution regarding the use of credit sensitive rates (CSRs) to replace LIBOR. To the good, IOSCO reiterated the importance of a “continued transition to robust alternative financial benchmarks, i.e., Risk-Free Rates, to mitigate potential risks arising from the cessation of LIBOR, including USD LIBOR.”

Over the past year, several CSRs have emerged to offer the market alternatives to the Secured Overnight Financing Rate (SOFR), the ARRC-recommended risk-free rate to replace USD LIBOR. (Additional detail on these CSRs can be found in the table below.)

In its statement, IOSCO expressed concern that widespread use of CSRs, instead of SOFR, may pose risks to financial stability. IOSCO highlighted SOFR’s robust underlying transaction volumes, observing they are “unmatched by other alternatives.”

IOSCO noted that CSRs will have to adhere to the IOSCO Principles on Financial Benchmarks  and that compliance with the IOSCO Principles is “not a one-time exercise and alternative benchmarks should be IOSCO compliant at all times.” In particular, IOSCO called on administrators to assess whether and to what extent the CSRs are “based on active markets with high volumes of transactions” and whether “such benchmarks are resilient during times of stress.”

Concern That CSRs Similar to LIBOR, Replicate LIBOR’s Shortcomings

Some of these rates are based on similar markets to LIBOR and may replicate many of LIBOR’s shortcomings, as highlighted by authorities in the US and UK. Users of benchmarks should also consider the robustness and reliability of the benchmarks they choose and ensure that they have reliable fallback mechanisms that can be used, should their chosen benchmarks cease or become unrepresentative.

– IOSCO Board
Global regulators responded to IOSCO’s statement voicing similar concerns:
Today’s statement by IOSCO further highlights the importance of using robust benchmarks when moving away from LIBOR. Markets should not risk the progress we've made by using supposedly credit sensitive rates that do not address LIBOR's fundamental weaknesses. These rates may well fail to comply with IOSCO Principles if their use became widespread. We need to learn the lessons of LIBOR, and ensure we transition to lasting solutions. I welcome IOSCO’s commitment to monitor the ongoing compliance of financial benchmarks, including credit sensitive rates, with its Principles.

– Andrew Bailey, Governor of the Bank of England
Compliance with all of the IOSCO Principles—consistently over time—is essential to a successful and lasting transition from LIBOR. With this in mind, market participants should now be moving to robust reference rates like SOFR to avoid jeopardizing financial stability.

– John C. Williams, President of the Federal Reserve Bank of New York

A Comparison Across LIBOR Alternatives

An overview of the leading CSRs is provided in the table below. Like SOFR, the CSRs incorporate a bank credit risk component, which some view as more robust that the credit spread adjustment embedded in LIBOR. However, as noted above, the underlying transaction volume of the CSRs is a fraction of SOFR’s underlying volume.

Contact

Raj Aidasani
Senior Director, Research
raidasani@crefc.org

Sairah Burki
Managing Director, Regulatory Policy
SBurki@crefc.org
IOSCO expressed concern that widespread use of CSRs, instead of SOFR, may pose risks to financial stability.
The information provided herein is general in nature and for educational purposes only. CRE Finance Council makes no representations as to the accuracy, completeness, timeliness, validity, usefulness, or suitability of the information provided. The information should not be relied upon or interpreted as legal, financial, tax, accounting, investment, commercial or other advice, and CRE Finance Council disclaims all liability for any such reliance. © 2021 CRE Finance Council. All rights reserved.
LIBOR Update – IOSCO Voices Concern Over Widespread Use of Credit Sensitive Rates
September 13, 2021
IOSCO issued a statement urging caution regarding the use of CSRs to replace LIBOR.

News

Update: ARRC Releases Term SOFR FAQs

August 27, 2021

On August 27, the Alternative Reference Rates Committee (ARRC) released frequently asked questions (FAQs) on best practice recommendations related to scope of use of SOFR term rates. As noted in an August 26 CREFC Alert, the markets and the regulatory community continue to prepare for the upcoming LIBOR cessation. The ability to utilize term SOFR rates is an issue important to CREFC members -- both balance-sheet and securitized lenders and servicers alike. 
  
The FAQs specifically and importantly address why limits to term rate scope of use are important, stating:

The rate should…have a limited scope of use, to avoid: 

1.     Use that is not in proportion to the depth and transactions in the underlying derivatives market;
or
2. Use that materially detracts from volumes in the underlying SOFR-linked derivatives transactions that are relied upon to construct a term rate, making the term rate itself unstable over time.

The ARRC’s recommendations related to scope of use of the SOFR term rate are intended to promote that objective.
In advance of its formal SOFR term rate recommendation, announced on July 29, the ARRC released recommended best practices for using SOFR term rates. 

Term Rate for Commercial Real Estate Loans and Securities They Collateralize.

The ARRC supports the use of SOFR term rates in areas where use of overnight and averages of SOFR has proven to be difficult. Specifically, the ARRC recognizes commercial real estate (CRE) loans as falling under the larger business loans category, which allows for the use of SOFR term rates in commercial mortgages and in turn the securitizations these loans collateralize. Please see the August 4 CREFC Alert for more detail.
  
The FAQs also address the use of SOFR term rate derivatives for end-user facing derivatives, defining such end-users as “a direct party or guarantor to a new SOFR term rate business loan or securitization-linked to SOFR term rate assets, or to a legacy LIBOR product that has converted to the SOFR term rate through contractual fallback language or legislation.”
  
Finally, the ARRC states that while the SOFR term rate is the first step of the waterfall in the ARRC’s recommended hardwired fallback language for business loans, FRNs, and securitizations, the ARRC believes it is appropriate “to use a daily SOFR rate as a bilaterally-negotiated fallback where counterparties see this as feasible, have hedging requirements, and wish to better align with ISDA fallbacks and current SOFR swap market conventions.”
 
The information provided herein is general in nature and for educational purposes only. CRE Finance Council makes no representations as to the accuracy, completeness, timeliness, validity, usefulness, or suitability of the information provided. The information should not be relied upon or interpreted as legal, financial, tax, accounting, investment, commercial or other advice, and CRE Finance Council disclaims all liability for any such reliance. © 2021 CRE Finance Council. All rights reserved.
Update: ARRC Releases Term SOFR FAQs
August 27, 2021
ARRC Releases Term SOFR FAQs

News

No Summer Lull for the LIBOR to SOFR Transition

August 26, 2021

ARRC Recommends SOFR Term Rates

The momentum behind the forthcoming transition away from LIBOR continues to grow. As covered in a recent CREFC Alert, on July 29, the Alternative Reference Rates Committee (ARRC) announced its recommendation of CME Group’s forward-looking Secured Overnight Financing Rate (SOFR) term rates. This move followed the completion of a critical change in interdealer trading conventions that occurred on July 26 under the CFTC’s SOFR First initiative. The initiative requires interdealer brokers to switch from their current LIBOR-based pricing conventions for dollar swaps transactions to one that uses SOFR-based pricing conventions.
  
The goal of SOFR First was to increase activity in the overnight benchmark rate, thereby growing the liquidity needed for a Term SOFR. In an August 4 post, Clarus Financial Technology noted that over the week of July 26, 12.3% of trades were SOFR Swaps, up from 2.5% to 4% in prior weeks.
  
In advance of its formal SOFR term rate recommendation, the ARRC released recommended best practices for using SOFR Term Rates. Please see the August 4 CREFC Alert for more details, but highlights for commercial real estate (CRE) include:

New Contracts

  • For new contracts, the ARRC supports the use of the SOFR Term Rates in areas where use of overnight and averages of SOFR has proven to be difficult. Specifically, the ARRC recognizes CRE loans as falling under the larger business loans category, which allows for the use of SOFR Term Rates in commercial mortgages and in turn the securitizations these loans collateralize.

Legacy Contracts: A New York Solution

  • Forward-looking Term SOFR is the first step of the waterfall for ARRC fallbacks, as well as for legacy products under New York State legislation (which was signed into law on April 6, 2021) and addresses tough legacy contracts or those that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions for LIBOR’s cessation. Following the formal recommendation of SOFR Term Rates, legacy contracts that have adopted the ARRC’s fallback language without modification to the rate waterfall will fall back to the SOFR Term Rates once the contractual LIBOR replacement date occurs.
  • LIBOR-based instruments governed by New York law that do not provide effective fallbacks will transition to the applicable SOFR-based rate recommended by the ARRC, the Federal Reserve Board, or the Federal Reserve Bank of New York. 
      

Legacy Contracts: A Federal Solution

  • Congress is also actively pursuing possible Federal legislation to solve the tough legacy problem. On July 29, the House Financial Services Committee (HFSC) passed a bill that would provide safe harbor for tough legacy USD LIBOR contracts if they switch to SOFR when the benchmark expires in June 2023. If the House and Senate vote to pass this bill, it will provide safe harbor under federal law for the toughest legacy contracts, including securitizations.
  • A Federal legislative solution is critically important given the following weaknesses in the New York State legislation:
    • Trust Indenture Act. Due to federal protections in the Trust Indenture Act (TIA), state legislation cannot adequately address some of the issues related to the LIBOR transition in many floating rate notes, as reported by Risk.net. However, Federal legislation would pre-empt the TIA, which is meant to protect bondholders from being negatively impacted by contractual changes, and is a “major obstacle to the state-level fix.”
    • New York Contracts Only. The New York law cannot address contracts issued from other states. For example, most securitizations may be issued under New York law, but the loans underlying these transactions could be originated in several different states and therefore governed by many different state laws.
  • LIBOR Replacement Rate – Point of Contention for Federal Legislation. Choice of replacement rate in a Federal law remains a point of contention. Supporters of alternatives to SOFR, such as Ameribor and BSBY, are advocating that these and similar rates be reflected in any Federal solution. While the proposed Federal legislation would provide safe harbor to only transactions that switch to SOFR, another Risk.net piece notes that an amendment to the bill, which was approved by the HFSC, adds a so-called ‘rule of construction’ that states “nothing in this Act shall be construed to disfavor the use of any benchmark rate on a prospective basis.” This type of language is not in the New York law.
  • CREFC will keep our members apprised of any significant developments as the Federal bill progresses through the legislative process.  

Growing Regulatory Impatience with Pace of SOFR Take-Up?

As year-end 2021 approaches, regulatory scrutiny on the financial sector’s LIBOR transition plans will certainly intensify. Earlier this year, banking organizations were put on notice by their supervisory agencies that they should stop originating LIBOR product by the end of 2021. On August 24, Treasury Secretary Janet Yellen, Federal Reserve Chair Jay Powell, Securities and Exchange Commission Chair Gary Gensler, New York Federal Reserve Bank President John C. Williams, and Commodity Futures Trading Commission Acting Chair Rostin Behnam released a letter to nonfinancial corporate stakeholders following a discussion of their experiences and concerns as they prepare to transition from LIBOR. 
  
This letter was in response to an April letter from the U.S. Chamber of Commerce, the National Association of Corporate Treasurers, and the Association for Financial Professionals, who shared that companies were finding it difficult to get LIBOR transition-related information from their banks. 
  
The regulators acknowledged the challenges that the corporations have faced in obtaining SOFR-based loan agreements. They state:

The transition is at a critical juncture, and we were thus concerned to hear your members report that nonfinancial corporations are, in most cases, not yet being offered such alternatives despite the short amount of time left in the transition. Accordingly, we invite you to continue to share your experiences and views with us as the transition, and the dialogue with your lenders, continues.
CREFC expects continued regulatory focus on the LIBOR transition and will share updates on both legislative and regulatory developments. 
 
The information provided herein is general in nature and for educational purposes only. CRE Finance Council makes no representations as to the accuracy, completeness, timeliness, validity, usefulness, or suitability of the information provided. The information should not be relied upon or interpreted as legal, financial, tax, accounting, investment, commercial or other advice, and CRE Finance Council disclaims all liability for any such reliance. © 2021 CRE Finance Council. All rights reserved.
No Summer Lull for the LIBOR to SOFR Transition
August 26, 2021
The momentum behind the forthcoming transition away from LIBOR continues to grow.

CREFC's Latest Presentations and Alerts

CREFC LIBOR to SOFR Transition Alert (August 4, 2021)
CREFC LIBOR UPDATE (July 2021)
Count Down... Transitioning Away from LIBOR Webinar    (May 2020, Members Only)
CREFC LIBOR Update (February 2020)
CREFC LIBOR Update (January 2020)
CREFC LIBOR Update: Implementing SOFR in Cash Products (January 2020)

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