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Goodbye LIBOR, Hello SOFR

From April 3, 2018, the Federal Reserve Bank of New York will start publishing the Secured Overnight Financing (SOFR) rate; a dollar-based replacement to the beleaguered LIBOR. The utility of LIBOR has been in decline for some time, as it is based on the estimated cost of unsecured borrowing as established by 20 contributing banks. As few banks now make such loans, LIBOR has become increasingly detached from market realities.

However, it was the high-profile rigging of LIBOR that put the final nail in its coffin, an event that was also one of the main catalysts behind the EU’s regulatory reforms. The centrepiece of these reforms, BMR, tightens up the administration and use of benchmarks that underpin financial instruments and contracts. The stringent regulatory regime that BMR puts in place demands much more transparent, accurate and robust benchmarks, reference rates and benchmark methodologies.

The days when rates could be determined on estimates is now long past; and the New York Fed’s suggested replacement, SOFR, is based on a much more rigorous, data-led inputs (in this case transactions from organizations including asset managers, money-market funds, insurance companies and others).

That one of the first possible replacements for LIBOR has come from the US, not only highlights the global importance of the rate (it is thought to support somewhere in the region of $350 trillion of securities) but also the interconnectedness of the global financial markets, and by extension, financial regulation. If any doubt remained that the ramifications of BMR will be felt well beyond the borders of the EU, then it should do so no longer. BMR is reshaping the benchmarks landscape globally, and all asset managers, banks and insurance companies need to ensure they have prepared for the changes ahead.

In particular, benchmark users need to be aware of which benchmarks and reference rates are likely to change or be withdrawn as a result of the Regulation. LIBOR/SOFR is a case in point. As reported in Bloomberg Businessweek, despite the importance of the LIBOR and the implications of its market withdrawal, many firms have not yet addressed their long-term exposures. It is critical they do so to maintain the good order of their businesses and on a wider scale the proper functioning of the financial markets.

The good news is that the market has responded to this requirement. New, ‘RegTech’ managed services have been launched that support firms through features such as inventory management, which gives users an immediate understanding of the universe of benchmarks used at their firm and their risk profile under BMR. These services, such as RIMES’ own RegFocus, reduce the cost, complexity and risk associated with BMR compliance while enabling businesses to focus on their core business activities. SOFR is just the beginning: many more big changes are ahead. Make sure your firm is prepared.

BMR and other regulatory topics will be discussed at RIMES’ upcoming EMEA Client Conference, which will take place in London on May 2. To register, email events@rimes.com.

 

 

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