If LIBOR ends, how can the structured finance market mobilize, respond and prepare for the transition to alternative reference rates?
The potential for the London interbank offered rate (LIBOR) to be permanently discontinued in 2021 is pushing a broad segment of the market, including those within the US securitization industry, to focus on their long-standing exposure to interbank offered rates (IBORs).
The complexity and scale of the transition from US dollar (US$) LIBOR to alternative reference rates (ARRs) is expected to be a significant transformation effort for market participants. The inherent complexities of securitizations further compound the already substantial issues associated with the LIBOR transition.
How the industry is getting ready
In the US, the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York convened the Alternative Reference Rates Committee (ARRC) to identity leading practices for selecting ARRs, and develop an adoption plan to facilitate the acceptance and use of ARRs on a voluntary basis. A working group within the ARRC is focused on developing approaches for the securitization industry to transition from US$ LIBOR to ARRs.
In June 2017, the ARRC identified the Secured Overnight Financing Rate (SOFR) as the rate that represents the best practice to use in certain new US$ derivatives and other financial contracts.1
A current priority for working groups in the US securitization market is to provide recommendations for fallback contract language to implement SOFR as a fallback for US$ LIBOR in new securitization transactions based on feedback from market participants. The language is designed to establish an effective fallback rate in the event that LIBOR is discontinued or is no longer usable. These working groups also consider the efforts of other product-specific working groups for derivatives and cash products to drive consistency in fallback language between asset classes and find solutions that reduce basis risk between the securities and the corresponding underlying collateral as well as any related hedges.
Industry groups are also expected to consider approaches to transition existing securitization portfolios referencing LIBOR and provide guidance to the market on ARRs being used as the reference rate within new securitization transactions.
Structured finance market participants — including banks, issuers, investors, trustees, rating agencies and servicers — should participate in or actively monitor these discussions to the extent appropriate for their exposure to LIBOR-linked products and contracts.