ARRC Still Not Ready for Term SOFR

The US benchmark body, the Alternative Reference Rates Committee (ARRC), which was convened by the Federal Reserve Bank of New York, has issued a set of market indicators that it says would allow it to better recognise a forward-looking benchmark to replace USD Libor.

The use of Libor is due to be ended for the start of 2022, however market participants are still calling for a forward curve for SOFR, the recommended Libor replacement. The ARRC says it has “long recognised that a forward-looking term SOFR rate will be a useful tool to support the transition away from Libor”, however it has failed to hit its self-imposed deadline of the middle of this year to recommend such a mechanism.

The indicators are intended to “provide clear guidance that would allow the ARRC to recommend a SOFR-based term rate relatively soon”. The ARRC see says they are designed to measure progress in establishing deep and liquid SOFR derivatives and cash markets—which are essential to a robust and stable term rate.

The market indicators the ARRC will consider in order to recommend a term rate are, not surprisingly, continued growth in overnight SOFR-linked derivatives volumes. The committee also says it wants to see “visible progress” to deepen SOFR derivatives liquidity, consistent with ARRC best practices. This entails electronic market-making and execution in SOFR swaps and swap spreads and a change the market convention for quoting USD derivative contracts from Libor to SOFR, as well as more making markets in SOFR-linked interest rate volatility products (including swaptions, caps, and floors).

The third requirement is again “visible” growth in offerings of cash products, including loans, linked to averages of SOFR, either in advance or in arrears.

The committee says the outlined steps should help further establish SOFR derivatives markets, and provide borrowers a range of choices based on SOFR. That said, it provides little sign a recommendation for a term structure is close, by reiterating it is not ready to make such a recommendation and by encouraging market participants “not to wait for a term rate and to make use of current SOFR conventions available now”.

Tom Wipf, ARRC chairman and vice chairman of institutional securities at Morgan Stanley, paints a more optimistic picture, however, by stating, “The market indicators outlined today are clear and achievable. Given recent market progress, I am optimistic that they can realistically be met soon as market participants continue to accelerate their move away from LIBOR to SOFR derivatives.”