If your business carries debt, the interest rate on that debt is likely to be linked to the London Interbank Offered Rate (LIBOR). LIBOR has been the standard benchmark rate for a variety of financial products since the early 1980s.
Following the LIBOR-manipulation scandals that came to light in 2012, regulators announced that what is often referred to as the "world's most important number," underpinning an estimated $350 trillion in contracts globally,1 will likely be phased out by 2021.
This article discusses syndicated loan market recommendations for implementing a replacement benchmark interest rate from the Alternative Reference Rates Committee (ARRC), a group of private-market participants convened to help ensure a successful transition away from LIBOR, and provides practical tips for borrowers to prepare their business for the transition.
SOFR to the Rescue
The ARRC has identified the Secured Overnight Financing Rate (SOFR) as the preferred alternative benchmark rate for U.S. dollar LIBOR transactions. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities in the repurchase market, and represents what is considered to be the nearly risk-free rate of borrowing. The SOFR rate is published each day at 8 a.m. ET by the Federal Reserve Bank of New York.
While the underlying market feeding into the LIBOR rate is small, mostly hidden from public view and handled exclusively by major global banks, a large range of observable transactions underlie the SOFR. Daily SOFR volumes reliably remain between $700 billion and $800 billion, and regularly exceed $1 trillion, making it a transparent rate that is representative of the current market across a broad range of participants, including money market funds, asset managers, corporates, insurance companies, securities lenders and pension funds. It is therefore far more protected from attempts at manipulation than LIBOR and is not at risk of ceasing to exist in the future.
However, many difficulties remain on the road to SOFR implementation. In most existing and newly inked contracts, the fallback rate after LIBOR ceases to exist is the prime rate (also referred to as the base rate or reference rate), which is the interest rate charged by banks to their most creditworthy customers and is nearly always more expensive for borrowers than LIBOR. To worsen matters, in transactions with more than one debt holder, changes to the interest rate generally...