SOFR is the interest rate solution, not another problem

A recent op-ed in American Banker mischaracterized the Secured Overnight Financing Rate — an alternative reference rate that has been critical to the financial system smoothly transitioning from the London interbank offered rate — and necessitates a response.

We appreciate different opinions on the best path forward in transitioning. However, it is critical to set the record straight and ensure that the conversation about SOFR is grounded and balanced.

First off, the Federal Reserve Board and the New York Fed convened in 2014 a broad group of industry stakeholders, called the Alternative Reference Rates Committee, to help facilitate a successful transition from U.S. dollar Libor. This process was in direct response to recommendations and objectives set forth by the Financial Stability Board and the Financial Stability Oversight Council.

The ARRC’s membership spans a broad and diverse set of private-market participants, including nonfinancial corporations, asset managers, insurers as well as a range of organizations, banks and official sector ex officio members.

Contrary to the assertions in the aforementioned op-ed, banks and bank-associated organizations form the minority of ARRC members, and there are no hedge funds among the ARRC’s membership.

Secondly, the SOFR is actually a very reliable rate based on a deep underlying market with a broad set of market participants, based entirely on transactions, not estimates.

It is also produced in compliance with international best practices. And it covers multiple market segments, ensuring robust transaction volumes in a wide range of market conditions, and across a range of market participants.

The Federal Reserve Bank of New York has published very detailed documentation regarding SOFR’s compliance with the principles of the International Organization of Securities Commission. They also release a full set of statistics regarding SOFR volumes and rate distributions in its underlying market every day.

Moreover, in the event that there is an increase in daily SOFR volatility, contracts referencing that benchmark typically rely on averages of daily rates. Those averages have been quite smooth and easily referenced in financial contracts, as demonstrated by the growing use of SOFR in futures, swaps and floating-rate debt.

Lastly, the op-ed mischaracterized a proposed legislation in New York Gov. Andrew Cuomo’s budget that is actually designed to be a targeted solution for a key challenge in the transition away from Libor. The proposal would establish a smooth transition mechanism for legacy contracts that have no effective fallback when Libor is discontinued.

This legislation would promote financial stability, reduce the burden on New York courts and leave room for any parties who want to try a different solution to opt out. The op-ed also glosses over the fact that, in order for the legislation to be effective, it must offer only one alternative rate to Libor. Otherwise, floating-rate note, securitization, nonfinancial corporate and derivative contracts would continue to face legal uncertainty when Libor ceases.

The ARRC’s proposal has the support of a broad set of market participants. Consumer advocacy groups have also supported the proposal, noting it provides consumer protections by offering certitude to borrowers, and alleviates concerns that lenders will seek to offload costs of the transition to consumers.

The proposed legislation is narrowly targeted at legacy contracts and does not have any bearing on the rates that are used in new loan agreements. While the ARRC’s position is that SOFR is the best alternative rate for broad use, we still support a vibrant and innovative market with reference rates that are robust and meet international standards.

We share the belief that ensuring a seamless transition away from Libor should be a top priority for the global financial markets. The ARRC selected SOFR as its preferred alternative after more than two years of transparent research and public consultation. The result of this exhaustive process shows that SOFR is the strongest alternative rate to Libor.