US: In 2017, the ARRC, the US working group tasked by the FED with identifying robust alternatives to USD LIBOR, selected the Secured Overnight Financing Rate (SOFR) as its preferred alternative to USD LIBOR. SOFR is a secured interest rate measuring the cost of borrowing cash overnight in the repo market, collateralized by U.S. Treasury securities. The liquid and active market underpinning SOFR makes the rate robust according to international standards.
The ARRC has led the transition away from USD LIBOR, publishing recommendations for the fallback language to be adopted in existing contracts, as well as best practices outlining key recommended milestones that market participants should aim to achieve to be prepared for the transition.
Among the most relevant developments, in July 2021 the ARRC formally recommended the use of SOFR Term Rates published by CME Group. Such rates can be used in the fallback clauses of existing contracts and in some specific type of new contracts, as indicated in the ARRC guidelines. In particular, ARRC supports the use of SOFR Term Rate for specific business sectors where adopting SOFR overnight could be difficult, e.g. multi-lender facilities and trade finance loans. (see ‘Sources’).
Similarly, US legislative authorities acted to ensure a smooth transition to the new benchmarks, especially for the so-called “tough legacy” contracts maturing after June 2023 and lacking a robust fallback language. The main institutional pillars are the Libor Legislation, signed into law in the New York State on April 7, 2021 and the inclusion of the “Libor Act” in the Consolidated Appropriations Act, bill passed by the Congress on March 14, 2022 and signed into law on March 15, 2022.
UK: In the United Kingdom, the Bank of England convened in 2015 the Working Group on Sterling Risk-Free Reference Rates (RFRWG) to select an alternative reference rate for sterling markets. In April 2017, the Working Group recommended the SONIA benchmark as its preferred RFR. SONIA is a fully transaction-based rate and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors. SONIA, introduced in March 1997, has been administered by the Bank of England since 2016 and reformed in 2018, to make it compliant with international best practices for financial benchmarks. The RFRWG, besides setting key milestones to guide market participants toward a smooth transition away from GBP LIBOR, is producing specific recommendations and best practices.
Unlike the US case, the UK RFR Working Group indicated to the market to adopt SONIA compounded in arrears as the prevailing choice for both fallback clauses of existing contracts and new contracts. The use of Term SONIA has been limited to a narrow group of financial products, specified in dedicated guidelines (see Sources).