On December 12, 2017, the Board of Governors of the Federal Reserve System (FRB) issued Notice 2017-26761 (82 FR 58397, Docket Number OP-1573) expressing its intent to begin publication during the second quarter of 2018 of three overnight repurchase transaction reference rates.  The FRB began publication of these rates through the Federal Reserve Bank of New York on April 3, 2018.

The three reference rates are intended by the FRB to increase transparency in the U.S. overnight Treasury repo market and for potential use by market participants as reference index rates for various financial transactions.  One of the rates, the Secured Overnight Financing Rate (SOFR), has been designated as the recommended LIBOR replacement index by the Alternative Reference Rates Committee (ARRC) organized by the FRB in the wake of the announcement by the Financial Conduct Authority of the United Kingdom that it would no longer compile the LIBOR index after 2021 as the result of a number of well-publicized LIBOR manipulation scandals.

The first of three new rates being published is the Broad General Collateral Rate (BGCR). The BGCR is a measure of rates on secured overnight Treasury repo transactions and is calculated based upon specific-counterparty tri-party repo transactions secured by U.S. Treasury securities plus General Collateral Finance repo transactions (GCF) cleared through DTCC’s GCF Repo service.

The second rate is the Tri-Party General Collateral Rate (TGCR), which is calculated on the same specific-counterparty tri-party repo trade information as the BGCR rate, but excluding GCF repo transactions cleared through the GCF Repo service.

SOFR is stated by the FRB to be designed to offer a broad measure of the costs of financing Treasury securities overnight.  The rate is calculated based on the tri-party repo transactions data utilized in the computation of the BGCR rate, plus data compiled from General Collateral Finance (GCF) Repo® transactions cleared by the Fixed Income Clearing Corporation (FICC) Delivery-versus-Payment repo service.  The SOFR rate differs from the LIBOR rate in that it is (i) based on actual historical transaction data rather than estimates now quoted by LIBOR participant banks, and (ii) derived from transactions secured by Treasury securities, rather than being unsecured as in the case of LIBOR.  Thus, it should be expected that the SOFR rate will prove to track somewhat lower than LIBOR, and not provide a perfect match replacement reference rate.

All the computed repo rates exclude transactions in which a Federal Reserve Bank is a counterparty.  The alternative rates are currently being published at 8:30 a.m. E.T. on the website of the Federal Reserve Bank of New York.  The New York Fed is publishing both current rates and past rates going back to August, 2014 in an apparent attempt to create a historical reference for using the rates in financial transactions going forward.

Much has been written regarding the potential phasing-in of SOFR as a LIBOR replacement index in the financial transactions markets, and this a developing story.  In the U.S. C&I lending industry, commercial banks are taking various approaches to an eventual LIBOR replacement.  At present, these include the continued use of LIBOR in new loan documents pending confirmation of widespread SOFR acceptance (the “wait-and-see” approach); the inclusion of general interest rate language to allow the lender to substitute an alternative “market” index in the event of LIBOR permanent unavailability or disruption; and the immediate adoption of SOFR or some other reference rate (such as Prime or a swap index rate) as the new index.  With the New York Fed making available historical data going back several years, there is at least published guidance for the third approach as to how SOFR would have tracked against LIBOR during this period.  However, the disappearance of LIBOR appears to be certain, and lenders and other financial market participants must develop their own definitive plans for addressing this multi trillion-dollar issue.