Takeaways from the June 3 ARRC Roundtable

Financial Industry Alert | June.05.2019

I attended the recent ARRC roundtable discussion on the LIBOR to SOFR transition and was struck by the tenor of urgency in the discussion – urgency to begin operational preparations for the transition; urgency to inventory risk in legacy instruments; urgency to, wherever possible, forgo continued LIBOR issuances and to issue based on SOFR; and urgency to encourage ISDA to adopt the pre-cessation triggers recommended by the ARRC for cash instruments.

Presenters from the Fed, ARRC, ISDA, American Bankers Association, Wells Fargo, JP Morgan, Morgan Stanley, Goldman Sachs, Prudential, Commercial Real Estate Finance Council, CME Group, LSTA, CFTC, FNMA, SFIG and National Association of Corporate Treasurers discussed a host of issues, including surrounding the market’s reluctance to shift from LIBOR, and made a strong case for considering SOFR as a benchmark for all credit transactions going forward, starting now. My key takeaways and some of the most memorable quotes from the discussion follow.

1. SOFR . . . Now!

  • Use SOFR now . . . when and where possible
  • Issuing SOFR based debt at this time is not “impossible”
  • Do not wait for a forward-looking term SOFR to be published
  • Term rate may not be available until end of 2021
  • Use the compound average rate, in arrears, which is what has actually happened, as opposed to the term rate, which is a guess about what will happen based on futures and swaps
  • The SOFR futures rate is growing and the swaps market is growing as well
  • However . . . LIBOR continues to be used at the current time in various markets
    • Still an element of inertia in the market
    • Lack of confidence in non-term rate for SOFR
    • Liquidity of SOFR derivatives market just starting and slowly
    • Liquidity charge to execute a SOFR swap remains a hurdle

2. SOFR issuances are growing

  • SOFR debt is being issued by ARRC members and others as well
  • Wells Fargo did one; a nonevent for investor base
  • Compounded average used for term adjustment
  • Compounded in arrears widely used
  • Compounding used in UK
  • Over $100 billion SOFR based FRNs in the last year
  • REMIC GNMA issue based on SOFR
  • SOFR linked debt by Fannie Mae
  • More efficient funding for issuers

3. Timing for end of LIBOR

  • Uncertainty remains; “cannot predict when LIBOR will go away”
  • Beginning the transition now is prudent risk management
  • Some continue to speculate that LIBOR will continue; “this is a distraction”

4. Legacy instruments

  • Legacy side is biggest issue
  • Amendments:
    • "Impossible" to get consents; "impossible" to identify noteholders
    • Hundreds of thousands of contracts that go past 2021; none of the fallbacks have been tested; operational challenge – a Herculean undertaking; “free form text”
    • Legislative relief in NY and other states under consideration
    • SFIG bondholder communication initiative
    • Can LIBOR continue for a few more years to close out legacy deals?
    • Convert legacy agreements to SOFR where possible; but accounting and tax clarification is needed to avoid deemed new issuance and gain or loss
    • There may be no solution
    • Inventory your risk!

5. Syndicated Business Loans/ FRNs/ Bi-Lateral Loans/ Securitizations/ Consumer Loans/ Derivatives!

  • Some differences in triggers and fallbacks, etc. for LIBOR based instruments
  • Consumer products – “highest standard of care to be used”; white paper on ARM product using overnight SOFR rate for new originations forthcoming
  • Derivatives: alignment of triggers is critical; choreography with ISDA protocol still a work in process; respond to ISDA consultation to urge adoption of pre-cessation triggers

6. Fallback provisions on LIBOR based instruments

  • Best described as seatbelts
  • They do not eliminate all value transfer
  • Discretion should be eliminated to extent possible to minimize litigation risk
  • Use the ARRC’s recommended LIBOR fallback language for loans, securitizations and floating rate notes for a more consistent and robust approach
  • Accounting, tax, operations – transition offices in place in many cases

7. Middle market borrowers

  • No uniform awareness of what is happening
  • Wells Fargo presented a LIBOR roadshow to its customers around the country
  • SOFR in arrears discussions with middle market customer base
  • Middle market customers appeared to be receptive to using SOFR
  • We need to make it easy to implement
  • An official index to alleviate the need to do calculations would help

8. This is a financial stability issue

  • “History will not judge kindly those who continue to use LIBOR at this time”
  • 2019 is a mission critical year
  • The transition will happen
  • The clock is ticking and the time is now
  • “When you are in a hole, stop digging”