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15 July 2021

Path to Term SOFR becomes clearer with selection of administrator

In our previous communication, we provided an update that CME Group has been selected as the administrator of an official term SOFR rate. This is a critical milestone for USD LIBOR transition, which has been lagging other transitions due to uncertainty around term rate availability. In this update, we provide further detail around this rate and the impact of this announcement.

The US Alternative Reference Rates Committee’s (ARRC) selection of CME Group as term SOFR benchmark administrator falls short of an official endorsement, however. An official endorsement has been delayed as the rate is not yet viewed as sufficiently robust, largely due to insufficient SOFR derivative liquidity.  As stated in its announcement selecting CME Group, the ARRC is waiting for certain market indicators to be present before providing its official endorsement. The ARRC has stated that, if SOFR liquidity increases, it is possible that it would be in a position to endorse this rate during 2021 (a significant win for the market). Official LIBOR cessation announcements made earlier this year will hopefully pave the way for an increased uptake of SOFR, a necessary condition for a robust SOFR term rate.

In the meanwhile, CME has made 1, 3 and 6 month term SOFR settings available. These benchmarks are based on CME Group’s underlying SOFR futures, making them a robust and sustainable measure of forward-looking SOFR rates. A statement of compliance with IOSCO benchmark principles has been made available by CME Group.

The term rate is available for licensing (free until December 2026), for limited use in cash market transactions only. The scope of use is limited in line with ARRC principles so as not to materially impact volumes in the underlying SOFR-linked derivatives market. CME Group intends to limit the licensing of its SOFR Term Rates to cash market transactions until June 30, 2023 (the cessation date for the majority of USD LIBOR tenors), with the result that the term rate cannot be used in derivative transactions until then. A 12 month tenor rate is currently in development and will be made available at a later stage. CME Term SOFR Reference Rates can be accessed from the CME Group website (delayed and historical data), the CME Market Data Platform or various licensed data vendors, such as Bloomberg and Refinitiv  (real-time data).

For further details around the term rates, their construction and how to access them, please consult the CME website.

The lack of certainty around SOFR term rates has been a sticking point for cash market participants, particularly corporates, for a long time. Regulator approved cash-fallback language has also embedded a contractual waterfall, with the use of term SOFR atop the waterfall, thereafter a less-preferred SOFR compounded in arrears mechanism. The absence of a term SOFR rate would thus be less than ideal for contractual parties who would then default to the second option in this waterfall.

With an official endorsed term SOFR rate on the horizon, this could mark a turning point in the transition away from USD LIBOR, both for legacy arrangements and new cash market transactions.

Standard Bank Group continues to follow the guidance set out by the regulatory authorities, market associations and official RFR working groups in the transition away from LIBOR. We are closely tracking updates around an official endorsement of term SOFR rates and will be in a position to communicate around the potential offering of these rates in due course. As usual, please do not hesitate to contact your usual relationship point of contact should you wish to discuss LIBOR transition and its impact on your exposures.