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Founded in the 1980s and marred by manipulation during the Great Financial Crisis, the U.S. Federal Reserve sought a replacement benchmark for LIBOR – the rate banks charged customers to borrow cash – that would eliminate fraud surrounding the lending rate. The Secured Overnight Financing Rate (SOFR) emerged as the universally accepted benchmark rate for trillions of dollars' worth of LIBOR-based contracts. All contracts were ordered to transition from LIBOR to an alternative contract by June 30, 2023.
A summary of the rise of SOFR, the de facto replacement lending rate to LIBOR, follows:
Why Use SOFR?
The U.S. Federal Reserve appointed the Alternative Reference Rate Committee (ARCC) to identify a replacement rate for LIBOR after years of negative headlines and scandal surrounding the rate banks charged to lend. The Secured Overnight Financing Rate (SOFR) emerged as the preferred alternate rate.
SOFR is a data-driven lending benchmark. It’s more reliable than its predecessor LIBOR and eliminates any manipulation by banks and provides more transparency to borrowing costs. It may only be used for U.S. dollars.
Challenges in the LIBOR vs. SOFR Transition
Replacing the rate was not without challenges. The trillions of dollars-worth of LIBOR contracts needed to convert to SOFR using equitable and fair methodology. As a result, some of the legacy loans that were tied to LIBOR required “fallback clauses” to ensure a smooth transition to SOFR.
Pricing of new-issue loans posed a challenge, too. Many were priced with a credit spread adjustment to compensate for the disparity between LIBOR and SOFR base rates.
Still, regulators recognized that some lenders would want options when it came to loan financing. Thus emerged Ameribor and BSBY, both of which would serve as alternative replacement rates.
No matter what rate was chosen by an institution, all loan documentation and contracts were given a June 30, 2023 deadline to transition to SOFR. Any credit agreements that were not renegotiated prior to the deadline were automatically rolled into SOFR.
The SOFR Solution
The implementation of SOFR eliminated fraud and manipulation that may have accompanied LIBOR. There were many considerations – such as fallback clauses and credit swap adjustments – that regulators took into account to make the transition seamless.
Renee Kuhl
Managing Director, Loan Agency tel:612-509-2323
Renee is the managing director for the Loan Agency Group for SRS Acquiom. As an accomplished financial industry professional, she leads the loan agency product.
Before joining SRS Acquiom, Renee served as an administrative vice president at Wilmington Trust, N.A., most recently leading the loan agency and restructuring products. In addition to her 10 years at Wilmington Trust, she also worked for Wells Fargo Bank, N.A. in the corporate trust and shareholder services departments.
Renee has a Juris Doctorate from Mitchell Hamline School of Law in Minnesota, and a B.A. in political science and history from Azusa Pacific University in Azusa, California.