The U.K.’s Financial Conduct Authority has put forward a proposal to replace the Libor rate with a new benchmark, which could be an alternative for companies that need more reliable long-term rates.
The what is libor is a benchmark interest rate that banks use to set their lending rates. Banks are now weighing alternatives as companies search for longer-term rates.
Some large banks are weighing whether the reference rate, which is supported by regulators as the best alternative for the scandal-plagued London interbank offered rate, should be the sole rate available to businesses, or whether they should provide other options.
As part of the move away from Libor, several major U.S. financial institutions are offering the Secured Overnight Financing Rate, or SOFR, to corporate borrowers.
However, according to banks and corporate advisors, SOFR may not meet all of a company’s requirements since it lacks rates that are weeks or months away, making it difficult for businesses to prepare for future interest-rate risk.
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Index rates such as the American Interbank Offered Rate (Ameribor) and the Bloomberg Short Term Bank Yield Index (BSBY) are being considered as alternatives by lenders. More study is needed to see how these alternative rates might perform in a downturn and if there is enough transaction volume to provide a credible reference measure, according to banks. While banks are being urged to provide SOFR for capital markets and derivatives, the Federal Reserve has said that it is open to alternative rate choices for loans and other financial products.
These credit-sensitive alternative rates to SOFR offer a more realistic representation of lenders’ financing costs. Duluth Holdings Inc., for example, obtained a corporate syndicated loan linked to BSBY in May, citing reduced borrowing rates, according to CFO David Loretta during a June earnings call. According to CreditRiskMonitor, a supplier of business credit data, Duluth has a comparatively low financial risk profile. A request for comment from the business was not returned. As the year-end Libor expiry deadline approaches, other corporate borrowers are seeking other rates.
After the government decided to phase out Libor by the end of 2021, the hunt for a new benchmark rate for business borrowings started. Banks have been fined, and some traders have been convicted, as a result of a massive manipulation scam. Libor was the reference rate for billions of dollars in financial contracts until then, and it helped determine borrowing rates on everything from corporate loans to mortgages across the world.
After December 31, banks will no longer be able to issue new financial contracts using Libor, although they will be able to use it for many current obligations until June 2023.
SOFR, which has risen to become the Fed’s and regulators’ preferred benchmark rate, is a backward-looking measure based on the cost of transactions in the overnight repurchase agreement market. Many banks and regulators favor this as a Libor substitute, claiming that it is stable enough to handle high volumes of transactions and financial products. Last month, a group of prominent banks, insurers, and asset managers approved “Term SOFR,” a set of forward-looking SOFR benchmarks released by CME Group Inc. to encourage wider market use. SOFR is built on a trillion-dollar market; for example, tens of billions of dollars are backed by Ameribor and BSBY.
Still, some smaller regional banks use Ameribor, a rate created by Richard Sandor, chairman and Chief Executive of the electronic marketplace American Financial Exchange LLC. They say the rate can change with their funding costs, reflecting what banks spend to lend to each other through mutual lines of credit. BSBY, owned by financial-data and media company Bloomberg LP, has also gained interest after Bank of America Corp. and JPMorgan Chase & Co. in May traded the first complex derivative using the index.
SOFR and BSBY are offered by Truist Financial Corp., a Charlotte, N.C.-based bank holding company, and PNC Financial Services Group Inc., but not Ameribor. Daryl Bible, Truist’s Chief Financial Officer, said the bank provides BSBY partly because it is comparable to Libor, making it a more familiar choice for clients, but that the bank is monitoring to see how many businesses use it.
As of Thursday, the rates for a three-month loan were 0.049 percent, 0.104 percent, and 0.097 percent, respectively, for Term SOFR, Ameribor, and BSBY. Because Ameribor and BSBY include a credit component, but SOFR does not, the rates reflect distinct underlying market circumstances.
According to Amanda Breslin, Managing Director of treasury advisory at financial-risk adviser Chatham Financial Corp., it’s difficult to say if one rate is better than the other since the proper credit spreads for each corporate borrower are also a consideration.
Wells Fargo treasurer Neal Blinde.
Photo: Wells Fargo & Co.
Credit-sensitive rates haven’t been written off by large banks, who say they’re keeping an eye on market movements and the performance of these index rates during market ups and downs.
Wells Fargo & Co. is researching the use of both Ameribor and BSBY in the commercial-loan market, said Treasurer Neal Blinde.
According to Goldman Sachs Group Inc. Treasurer Beth Hammack, the firm is evaluating whether to provide credit-sensitive rates depending on client demand and index strength.
Banks and their corporate borrowers will also need to demonstrate to authorities that they are working swiftly to establish a new standard.
“Our real concern for financial stability is to ensure that every contract has language stating what happens if the contract’s chosen reference rate becomes unavailable, because any reference rate can die,” said Randal Quarles, chair of the Financial Stability Board and vice chairman for supervision at the Federal Reserve
Goldman Sachs Group treasurer Beth Hammack.
Ben Baker/Goldman Sachs photo
BSBY poses comparable threats to financial stability and market resilience as Libor, according to Securities and Exchange Commission Chairman Gary Gensler. In a speech to the Financial Stability Oversight Council in June, he noted that both benchmarks are based on unsecured, term, bank-to-bank lending and that they are a small market carrying a large number of transactions.
Mr. Gensler said at the time, “When a benchmark is misaligned like that, there’s a heck of an economic incentive to manipulate it.” The Securities and Exchange Commission did not reply to a request for comment.
It’s uncertain when most big banks will make a decision on alternative rate offers. Mr. Blinde of Wells Fargo said, “Our company’s emphasis has really been all of the product releases and preparation surrounding SOFR.” “It’s too early to tell if we’ll be involved in the other markets, but we’re definitely looking into it.”
Mark Maurer can be reached at [email protected]
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