With Libor expected to be phased out by the end of 2021, alternatives to the benchmark rate are emerging across the globe. Mechanisms for establishing contractual fallbacks and adjustments to Libor-indexed financial instruments are being developed to minimize disruption, if in fact it does go away in 2022.
During a recent AFP Conversations podcast interview, sponsored by Santander, we discussed the implications that Libor’s end could have for financial professionals. Robert Owens, director of fixed income strategy for Farmer Mac, and Ruth Hardie, senior director of client services for Hedge Trackers, shared their insights.
Andrew Deichler: So you both generally believe that Libor is going to end after 2021. Robert, are you making preparations now? A lot of treasury professionals have been putting this off, but it sounds like you're being proactive.
Robert Owens: Yes. We are issuing SOFR bonds. We are entering into SOFR derivatives. We are actually exploring other IOSCO-compliant indexes like Ameribor and talking with our customers about SOFR and Ameribor.
Andrew Deichler: SOFR has been what everybody in the U.S. seems to think will be the alternative reference rate that that we'll be moving to. But there hasn’t been as much discussion about Ameribor. So maybe you could talk a bit about what Ameribor is, and what treasury and finance professionals should know about it.
Robert Owens: Sure. Ameribor is a daily rate. It's IOSCO compliant, like SOFR. It’s not really a competitor; it’s more complimentary. It's basically unsecured bank credits transacting among each other. And it's about $2 billion a day of volume and growing. It uses blockchain technology, so it can't be manipulated or anything like that. I find that really attractive. But the big thing is, there are over a 150 member banks and over 1,000 correspondent banks participating in transactions that are building this index. And the transactions are on the American Financial Exchange and it's very transparent. [Richard Sandor], who started Ameribor, also started Treasury futures. He's a very innovative thinker and it's a nice alternative. Obviously SOFR is a dominant alternative, but I think Ameribor has a nice place, especially in rural America.
Andrew Deichler: Interesting. So Ruth, for the treasury clients that you've spoken with, are you seeing interest in Ameribor? Are they aware of it? Or are they focused on SOFR? Or neither?
Ruth Hardie: We're definitely focused on SOFR because it's been approved as a benchmark rate by the [Financial Accounting Standards Board (FASB)]. In order for Ameribor to take off in the hedging world, it will have to become a benchmark. I understand that the FASB is looking at it and considering it for a benchmark, but until that time, my clients tend to take their lead from what the regulators are doing. They're actively watching the FASB, and the FASB recently has come up with a new pronouncement of how to make the transition easier. So far we've seen nothing from Ameribor. It'll be interesting.
Andrew Deichler: Do you think the treasury and finance professionals understand that they need to start making a move? Because we've spoken to a lot of them, as well as other experts, and they have mostly said that they're just not taking action yet. They're just kind of waiting and seeing how this is going.
Ruth Hardie: I would say that's an accurate assessment. A lot of people are waiting, but I have some clients who have actually moved off of LIBOR already. They've gone exclusively into [overnight indexed swap (OIS)] as kind of an intermediate measure until SOFR is out there really actively trading on the swap market. But most of my clients at this point are taking a wait-and-see approach and we kind of recommend that for a typical corporate client that doesn't do a lot of trading. They don't want to be the first out there because the market is not liquid enough for them. They need to wait until the big guys are out there and they're playing in the field. But at the same time, we're warning people, you don't want to be on the tail end either because you may not have any leverage at that point. We're expecting that the market's going to be difficult for the next couple years—that it's going to be less transparent. There's going to be arbitrage opportunities. And ideally our clients will stay out of that to the extent that they can because they're hedging. That's what they're out there doing. They're not trading for profit.
Andrew Deichler: Before our interview, you had mentioned that Farmer Mac is one of your clients and they're kind of a market leader and they're going full on into SOFR. Do you both expect other corporates to follow your example as you make this transition?
Robert Owens: I believe it's binary. In general, large financial firms and [government sponsored enterprises (GSEs)] are actively trying to move away from Libor and build a SOFR market. But I think if you're not a large financial firm, you’re just not involved in it yet. But I think you should be. I think anybody with Libor exposure needs to start assessing SOFR or Ameribor, or even look at OIS like fed funds OIS as an alternative. Just limit your LIBOR exposure as much as you can.
Andrew Deichler: Sure. But for those companies that have Libor exposures, particularly in existing contracts, we've seen the SEC and the [Alternative Reference Rates Committee (ARRC)] talk about companies implementing fallback language to protect themselves. Do you think that that's a worthy effort? Or do you think they should just work to move beyond Libor?
Robert Owens: I believe they should work beyond Libor. I'm on the ARRC floating rate note committee and fallback language is a lot more robust. But even [David Bowman, Senior Advisor of the Board of Governors of the Federal Reserve and a member of the ARRC] said that it's not infallible. It's a lot better, but it's not infallible. The quicker you're off of Libor, even with the robust fallback language, the better.
Ruth Hardie: One of the things that corporates are dealing with though is, they've got existing contracts that go out 30 or 40 years—way into the future. As you had mentioned, the SEC has gotten on board and really dealt with probability first. And then the International Accounting Standards Board (IASB) has dealt with probability, and the FASB has an exposure draft out there dealing with probability. Because honestly without that right now, hedge accounting should stop because it's not probable. I don't think you can any longer say Libor's probable after 2021. It's possible, which gets into kind of the hedge accounting nuances, which are very important, but it's really not probable at this point.
The clients that we've had move off [from Libor] so far are financial institutions. On the corporate side, they have their derivatives to look out for. If they're in interest rate derivatives, they have a lot more than that that's going to be impacted by Libor going away. They need to be looking at all of their contracts, their transfer pricing, their intercompany loans—everything. And it's not just in the U.S., it's global that Libor is going to end. They are looking at it and they're starting to think about it. They’re mostly just gathering information at this stage and waiting for the regulations to catch up.