For a minute there, it seemed like global regulators were postponing the death of Libor yet again.
The plan was that ICE would stop publishing the scandal-ridden benchmark at the end of June 2023. Then the FCA announced Monday that daily rates would be published through September 2024.
But there’s something funny about the “synthetic US dollar Libor” that will be introduced July 1.
The new rate isn’t supposed to measure the same thing as Libor did, the FCA says. The prior versions of Libor, however illiquid or “stale”, were meant to capture the cost of unsecured bank funding.
Interesting, right? So . . . what does the new “synthetic US dollar Libor” capture?
From the FCA:
We have decided to require IBA to calculate the 1-, 3- and 6-month synthetic US dollar LIBOR settings using the relevant CME Term SOFR Reference Rate plus the respective ISDA fixed spread adjustment.
Wait . . . that’s just the benchmark that regulators have already picked as a replacement for Libor!? Hahahaha amazing.
This is a clever solution to the problem of all those outstanding debt contracts whose interest rates are still based on Libor: you don’t have to renegotiate every contract if you’re going to make the process this difficult! Regulators will simply change the definition of US-dollar Libor so the industry uses their chosen benchmark anyway!
Corporate treasurers may not be as tickled as we are about the change. Mentions of SOFR have already come close to overtaking mentions of Libor in 10-K reports, according to this handy chart from Nick Mazing, director of research for AlphaSense:
Take for example these lines from the 10-K of YETI Holdings, a company that sells popular drinkware and coolers:
It is possible that the volatility of and uncertainty around SOFR as a LIBOR replacement rate and the applicable credit adjustment would result in higher borrowing costs for us, and would adversely affect our liquidity, financial condition, and earnings. The consequences of these developments with respect to LIBOR cannot be entirely predicted and span multiple future periods but could result in an increase in the cost of our variable rate debt which may negatively impact our financial results.
And Lifetime Brands, a kitchenware company, says the “replacement of the LIBOR benchmark interest rate with SOFR could increase the Company’s borrowing costs.”
The FCA’s decision should remove some uncertainty around these companies’ negotiations, though it may not lighten the tension; with US rates above 4 per cent, every basis point matters.
But ultimately, the announcement means we’re almost through with the long and arduous process to kill off Libor.
Remember, it took years of roundtables, meetings and consultations for US regulators to settle on the Secured Overnight Financing Rate, or SOFR, as their new preferred benchmark. SOFR is based on the market for overnight loans secured by Treasuries, which usually totals more than $1tn in daily volume.
And after fielding numerous industry complaints, regulators have (hesitantly) ushered along (some) solutions for the challenge of replacing a rate on monthslong unsecured loans with a rate on overnight loans secured by ultra-safe government bonds. CME has built a term structure for one-, three-, six- and 12-month SOFR maturities, and ISDA has introduced credit spreads to reflect the difference in credit risk between Libor and SOFR.
So it’s a stretch to argue this is rule by decree.
But it does bring to mind an old joke: How does the FCA change a lightbulb? It declares darkness the new industry standard.
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